Part 8: How the Local Authorities (Members' Interests) Act 1968 operates

Local government: Results of the 2008/09 audits.

8.1
We are aware that how the Local Authorities (Members' Interests) Act 1968 (the Act) operates has created some concern in the sector during the last year or more. In this Part, we discuss:

8.2
This discussion is intended to provide the sector with more certainty about how we are approaching the Act's requirements, and what people need to do to comply. It also highlights that there are some problems with the Act that cannot be solved without legislative reform.

What the Act does

8.3
The Act is unusual in the public sector. It sets some firm rules on the management of financial conflicts of interest for elected members and backs these rules with criminal offences and penalties. The Act is also unusual in that it gives the Auditor-General a decision-making and approval role, and also a prosecuting function.

8.4
The Act has two main rules, which we refer to here as the contracting rule (in section 3 of the Act) and the participation rule (in section 6 of the Act):

  • The contracting rule prevents a councillor from having interests in contracts with the local authority that are worth more than $25,000 in a year, unless the Auditor-General approves the contracts. Breach of the rule results in automatic disqualification from office.
  • The participation rule prevents a councillor from participating in a decision in which they have a financial interest, other than an interest in common with the public. The Auditor-General can approve participation in limited circumstances. Breach of the rule is a criminal offence, and conviction results in automatic disqualification from office.

8.5
Both rules have a complex series of subsidiary rules about their scope and exceptions.

8.6
For many years, our work under the Act has mostly related to administering the contracting rule and requests for approval of contracts. In the past, queries or complaints about the participation rule were less frequent – usually when councillors sought approval to participate in a particular decision. However, that pattern has been changing during the last two years. We have seen a significant increase in the number of allegations that councillors are participating in decisions that they should not, as well as in the number of general requests for advice.

The Auditor-General's role under the Act

8.7
The Auditor-General has two formal roles under the Act:

  • to consider applications for approvals or exemptions under both rules; and
  • to investigate and, if necessary, prosecute councillors who breach the Act.

8.8
We have a strong focus on providing guidance and assistance to help councillors and council staff to do the right thing and avoid breaches of the Act. For many years, we have published a guide to the Act,66 which we update around the time of local authority elections. Occasionally, we provide training on the Act's requirements and our administrative processes for applications. We also regularly talk through issues with council staff or councillors when they are uncertain about what to do.

How we approach investigations into possible breaches of the Act

8.9
Our approach to investigating potential breaches of the Act has traditionally been low key. We are aware that investigations inevitably involve intrusion into the personal financial affairs of the councillor because we need to understand the extent and nature of their personal financial interests. The fact of an investigation can also affect a person's reputation, even if the investigation determines that they have not breached the Act. If the investigation suggests that a councillor has breached the Act, the issues can be tested in court. Therefore, our usual approach is not to publicise this work, or to provide details of our findings and analysis.

8.10
However, during the last year or more, we have investigated publicly made allegations of breaches of the Act that have attracted considerable local public interest. In those situations, we have decided that it better serves the public interest for us to report more fully on our investigations and conclusions.

8.11
We have recently noted an increase in the number of allegations of breaches being made to us, many of which prove not to be well-founded when we investigate. We are concerned about the personal and administrative cost for the individuals and council staff when we investigate a breach, particularly if the allegation and the fact of an investigation are also made public. We intend to consider carefully which complaints warrant investigation and to require some evidence of a potential breach rather than simple assertions before we respond.

Our investigation into possible conflicts of interest by Environment Canterbury councillors

The complaint and the facts

8.12
We received a complaint in July 2009 that three councillors at Environment Canterbury (the Council) had breached section 6 of the Act by discussing and voting on a proposal to recover the costs of managing water resources. A complaint about a fourth councillor was added later.

8.13
The proposal that the Council considered was to recover $2.2 million (31%) of its water management costs from holders of certain types of consents, through charges imposed under section 36 of the Resource Management Act 1991 (the RMA). Previously, all the costs had been met from general rates. The proposed charges would be limited to holders of permits to take ground water and surface water, and to holders of permits to discharge contaminants either to land or water. The charges would differ depending on the location and type of the consent, and the amount of water taken and/or type of contaminant discharged.

8.14
Four councillors were potentially affected by the proposal, because they or their spouse held relevant consents either in their own name or through companies in which they were shareholders.

8.15
The proposal came to the Council at two meetings in 2009. The first meeting was on 5 March 2009, when the Council – as part of the draft long-term council community plan (LTCCP) process – was required to vote on whether to approve the draft fees and charges for 2009/10 for consultation. Three of the four councillors participated in the discussion and voting. One councillor abstained.

8.16
The Council then met on 4 June 2009 to consider submissions and adopt the final LTCCP. There were a number of motions put to the Council at the meeting about the charging proposal. All four councillors participated in the discussions and decisions made during this meeting.

8.17
Council staff calculated that the effect of the charges on two councillors would have been small and would have been outweighed by their savings in general rates. For the other two councillors, the charges would have been more significant, with overall net costs of $977 and $1,628.

Our analysis

8.18
We began our analysis by considering whether the four councillors had a financial interest in each of the decisions. We concluded that at the point of the first decision, in March, the proposal included several different options and could still change significantly as a result of the consultation. There was enough uncertainty about the final shape of the proposal for us to be satisfied that at that point the councillors could not be regarded as having a reasonable expectation of loss or gain of money as a result of the decision being made. Therefore, they did not have a financial interest in that decision.

8.19
The decision in June was different, because by then submissions had been received and the Council was making final decisions on what charging regime to implement. At this point, we regarded the councillors as having a reasonable expectation that the proposal would affect them financially. Therefore, each of them had a financial interest in these decisions.

8.20
We carefully considered whether the councillors' financial interests could be regarded as interests in common with the public. Most decisions about rating and charging, including targeted schemes, are broad enough in their application to be regarded as affecting the public generally. We gathered information on the number of ratepayers in the region, and the proportion of them who held RMA consents. A further subset held consents that would be subject to the proposed water charges – about 2.7% of ratepayers. We concluded that the interests of those consent holders were different in kind and extent from the interest of the general public (whose rates would slightly decrease), and that they formed a small and clearly identified subset of the population.

8.21
On balance, it was our judgement that the interests of the four councillors, who as consent holders were subject to the charges, were not interests that could be regarded as interests in common with the public.

8.22
We went on to consider the various exceptions in the Act, and concluded that none applied in this situation. Therefore, all four councillors had breached the Act, despite the fact that some of them had very small interests. However, we noted that this was the type of situation where we would have considered an application to approve participation, if the councillors had applied for an exemption in advance.

Our decision on prosecution

8.23
Next, we had to consider whether it would be appropriate to prosecute in this situation. We concluded that it would not, for several reasons. One of the councillors had specifically sought legal advice about this issue, and had shared it with the other councillors. That advice had said that they were able to participate. Although we disagreed with the advice, councillors had taken advice on what was appropriate. Other relevant factors included that we would have seriously considered permitting participation if we had been asked at the right time, and that the financial interest for most of them was small.

8.24
We were aware that our judgement on whether a financial interest existed was a finely balanced one, and highly fact-specific. We knew that our decision on prosecution might also be controversial. Therefore, we asked the Crown Law Office to review our decision. That Office agreed both that a breach of the Act had occurred on these facts and that it was not appropriate to prosecute.

8.25
Given the level of public interest in our investigation and the issues relating to the Council and water management in the region, we released a full report explaining our decision in December 2009.67

The process and decisions that followed our investigation into Environment Canterbury

The decisions that Environment Canterbury still had to make

8.26
Our investigation focused on decisions that had already been made. However, the Council had to make further decisions on the proposed water charges because the implementation of the charges had been deferred to allow further and more detailed community consultation.

8.27
Therefore, the Council, on behalf of all four councillors, applied for exemptions to enable them to participate in the decisions that were to come. These decisions related to the final shape of the charging scheme and its implementation, followed by the incorporation of the effects of that decision in the next budget and annual plan.

8.28
After further consultation, the detailed implementation of the scheme had changed a little and so the Council provided us with updated information on the charges that would apply to each councillor. Each councillor also gave us a summary of their financial situation, to enable us to assess the significance of the charges.

Approvals to participate because the interests were not significant

8.29
Three of the councillors had interests that we regarded as insignificant in terms of the Act. The test in the Act is that the financial interest is so remote or insignificant that it cannot reasonably be regarded as likely to influence the councillor's participation.

8.30
For the four councillors, the effects were predicted to be:

  • under $40;
  • between $50 and $300;
  • between $600 and $1,800; and
  • between $1,200 and $9,000.

8.31
We considered these effects against the total expenses of each person's businesses. Given that these were farming or rural businesses, the total outgoings were generally large.

8.32
For the first three councillors, we concluded in each case that the effect was insignificant in the context of the individual's financial situation and could not reasonably be regarded as influencing the councillor's views. Therefore, we gave general approval for them to participate in all of the remaining decisions on this issue.

8.33
We decided that we could not give an approval under this provision for the fourth councillor. We regarded a potential charge of up to $9,000 as significant enough that it could reasonably be regarded as influencing her views.

Our decision on an application to participate on democratic grounds

8.34
We then considered whether to grant approval to the fourth councillor under section 6(4) of the Act. Under this provision, we can grant approval when we are satisfied that applying the prohibition would impede the transaction of business by the local authority or that participation would be in the interests of electors.

8.35
The factors that we identified as relevant included:

  • The decision on whether and how to impose the water consent charges was to be taken first and separately from the more general decisions on the overall annual plan and budget for the year.
  • The constituency represented by the councillor was a large rural one likely to be affected by the proposed charges, so the question of representation was important. However, the primary purpose of the representative role is to ensure that the views of the community are understood when decisions are made. In this case, the Council was already well informed about the views of the community as it had carried out a significant amount of consultation, including very recent and specific local consultation.

8.36
We decided that the fourth councillor's personal financial interest was direct and significant enough that she should not be able to participate in the Council's decision on 11 February 2010, which was specifically on the adoption of the funding methodology for those charges. Although the representative role is important, we regarded the perspective of those she represented as being well understood by the Council. Therefore, we did not grant her a declaration to enable participation in that particular decision.

Our approach to participation in the more general decisions that followed

8.37
We took a different view on the decisions that followed, which related to more general business about the overall budget and annual plan. We considered that the councillor did not have a financial interest in those more general decisions, even though they incorporated the effects of the decision on the water charges. Therefore, the prohibition was limited to the specific decision on applying the charges and the methodology to be used. Given the democratic context, we regarded it as important to limit the disqualification to the direct decisions only.

8.38
We confirmed this view for the Council for all of the planning decisions that followed, and continued to regard it as appropriate for all councillors to participate in those general matters.

Overall comments

8.39
The Council's situation presented a particularly complex set of issues, and involved an unusual combination of circumstances. We do not expect such issues to arise frequently.

8.40
The key issue was whether the interests of the councillors could be regarded as interests in common with the public. The particular characteristics of the type of user charges being proposed, and the fact that the subset of the population to whom they would apply was so small and readily identified, were both significant.

8.41
Another factor was that the decisions in question were whether to adopt the charges and what charging methodology to apply. So, the effect of them on the individuals was reasonably clear and direct.

8.42
For the councillor whose financial interest was very small, it is arguable whether that needed to be recognised and approved at all. But for the other councillors, the financial interest was significant enough that it was appropriate to seek approval to participate, given the way the Act is written.

General principles to consider when applying the Act

8.43
We are aware that our decision in this case has caused some concern in the sector. We have received many requests for advice and guidance since then, and several requests for approvals to participate. Our decision has also come up regularly in our general discussions with local authorities.

8.44
Although we see the Council's situation as relatively unusual, we note that it highlights that the Act is not well designed for the decision-making needs of modern local authorities. In particular, it is not well equipped for dealing with targeted rating and charging decisions, and a "user pays" environment. We discuss these problems below.

8.45
We are concerned that many individuals and elected members have become unduly risk-averse as a result of the publicity about this decision. We emphasise that the Council's situation involved an unusual combination of factors; we do not expect similar situations to arise very often. General charging and rating decisions of this kind would usually be covered by the "interest in common with the public" test.

8.46
To help councillors and council staff, we are producing further guidance material on the principles and factors to apply to work out whether there is a financial interest that might prohibit them from participating in council decisions. For those who wish to apply to us for approvals to participate, we will be making clear what information we need to be able to process the application promptly. We summarise that guidance here.

What is the decision being made?

8.47
The nature of a particular decision can be important. There are many situations where the decision is in fact a procedural one, or a more general decision – for example, a decision to approve an overall budget to be included in a consultation process – rather than a decision on whether to agree to a specific proposal.

8.48
We recognise the importance of the democratic context in which the Act applies. Therefore, we take a cautious approach to disqualification so that any limits on participation resulting from the Act are clearly defined. Although a councillor may be disqualified from participating in a specific decision as a result of a financial interest, we are often able to determine that the interest does not prevent them from participating in more general decisions that may incorporate the result of the specific decision. Again, Environment Canterbury's situation provides a useful illustration of this approach, in that the fourth councillor was able to participate in the subsequent overall budget and planning decisions, despite her personal interest in the specific proposal on water charges.

Do I have a financial interest in that decision?

8.49
Deciding if you have a financial interest in a decision can be difficult. The Act's definition of what counts as a financial interest includes many scenarios. The interest can be direct or indirect and can be held by you or your spouse. Certain company interests are also specifically included.

8.50
Having identified a relevant interest, it is also important to check that the interest will actually be affected by the particular decision that is to be made. Often, we find that a councillor has a financial interest in an issue, but that it will not be affected by the decision that the authority is about to take. For example, the decision may only be to raise an issue for discussion or to begin a research or consultation process. That decision may not have any particular effect on the councillor's financial interest.

8.51
In a number of our recent decisions, we have emphasised the importance of this aspect. The definition of financial interest that we use is:

Whether, if the matter were dealt with in a particular way, discussing or voting on that matter could reasonably give rise to an expectation of a gain or loss of money for the member concerned.

8.52
This point picks up on the concept of "reasonable expectation". Many council proposals move slowly through many stages – from a general idea, through development and consultation, to a firm proposal and implementation. When a proposal is in the early stages of general discussion and development, it may not be far enough advanced or clear enough for the councillor to have a "reasonable expectation" of gain or loss. There may be a general possibility, but nothing concrete enough to amount to an expectation. That obviously changes as the issue moves towards a fully developed proposal ready for adoption and implementation. Councillors need to be careful in recognising when a proposal reaches the stage where it affects their financial interest and they should no longer participate in the decision-making process.

Is the interest in common with the public?

8.53
There are no hard and fast rules on whether an interest is held in common with the public. However, the two extremes are simple. For example:

  • A general rating decision clearly affects everyone and the interests of councillors in that decision will be in common with the interests of all ratepayers.
  • A decision that affects property values in one street that includes a councillor's home or business clearly affects only a small number of people and affects them directly. The councillor's interest is not held in common with the public.

8.54
In between these two extremes there is considerable room for judgement. We do not consider it possible to define a simple threshold of the number of people who need to be affected, or a percentage of the population, or the size of the effect on the individual – although all of these factors may at times be relevant. In each case, the individual facts will matter.

8.55
After our decision about Environment Canterbury, a number of people seem to have assumed that any targeted rate or charge will automatically cause a problem for the councillors that it affects. We do not agree with that view. Almost all rating decisions, including targeted rates, will affect interests that are held in common with the public. The same is likely for most charging and "user pays" decisions.

8.56
For several complaints that we received during the last year or more, we concluded that targeted decisions that affected councillors as part of a group were not problematic. In those cases, the group represented a reasonable proportion of the relevant population and was defined in general terms. The effect of the decision on any individual property was also far from clear. By contrast, in the decision about Environment Canterbury, the affected groups were quite specifically identified and were a small subset of the general population, and the effect of the charge on them was different in kind and extent from the effect on others.

Do any of the other exceptions apply?

8.57
The Act lists a number of detailed exceptions when the participation rule will not apply. We do not go through these here, but note that checking them is another important step as people consider how the Act applies to their situation.

Could I apply for approval to participate?

8.58
If a councillor has a financial conflict of interest covered by section 6 of the Act, it is possible to apply for approval to participate. There are two ways in which we can approve participation:

  • Section 6(3)(f) allows the Auditor-General to grant an exemption if, in our opinion, a councillor's interest is so remote or insignificant that it cannot reasonably be regarded as likely to influence the councillor when voting or taking part in the discussion.
  • Section 6(4) allows the Auditor-General to grant a declaration enabling a councillor to participate if we are satisfied that:
    • the application of the rule would impede the transaction of business by the authority; or
    • it would be in the interests of the electors or inhabitants of the district that the rule should not apply.

What information do we need to assess applications?

8.59
For an application under either of these provisions, we need to understand in reasonably precise terms both the nature of the decision that is to be made by the local authority and the nature and extent of the councillor's financial interest. That information is important to enable us to assess whether there is a financial interest in the particular decision that is covered by the Act. We also need this information to assess how significant the decision and the personal interest are. In practice, it is often helpful if the authority is able to provide us with a draft copy of the paper that is to be submitted.

Applying under section 6(3)(f) of the Act

8.60
When we are considering an application under section 6(3)(f) of the Act, we need to understand how directly the proposed decision is connected to the person's interest (the remoteness ground). We also need to understand how large or important the personal interest is. That means we need reasonably precise information (if it is available) on the value of the cost or benefit that will result from the decision. It is also useful to be able to assess any cost or benefit in the context of the overall financial situation of the person or business. A cost that might be significant at an individual level may not be so important if it is borne by a large business.

8.61
The test in the Act is an objective one. Although the views of the councillor about how significant the interest is and whether it is shaping their position on the issue are relevant, they are not determinative. Ultimately, we must assess how significant the interest looks to an observer.

8.62
For example, in the situation of Environment Canterbury, we concluded that potential financial effects ranging between $40 and $1,800, in the context of sizeable farming and business operations, could be regarded as insignificant and unlikely to affect the councillors' views. However, we did not consider that a financial effect of up to $9,000 could objectively be seen as insignificant, even in the context of a major farming property.

Applying under section 6(4) of the Act

8.63
We need additional information when we are considering applications under section 6(4) of the Act. To assess whether the rule would "impede the transaction of business", it is useful to receive information on how many councillors might be prevented from participating, how significant the decision is for the region and the authority, and any other information that can help explain to us why it might be problematic if a councillor was not allowed to participate.

8.64
For example, we have at times granted applications on this basis when a number of councillors might otherwise have been prevented from participating in a decision on the future of a major council shareholding in a listed company.

8.65
To assess whether it would be "in the interests of electors or inhabitants" for a councillor to be able to participate, we need to assess the benefits of allowing that councillor to participate against the risk that their participation could be regarded as distorting or tainting the decision. Therefore, we need information on why that councillor's participation is important. It may be because they have particular expertise or knowledge, or provide an important link with another organisation or community group. It may be that the issue is so significant for the community that the participation of all elected members is seen as more important than any individual interests. There may be a strong representation argument that the views of a particular group or community would not otherwise be able to be represented at the council table.

8.66
For example, we have granted an application on this basis when the decision related to a council position in a submission on a long-term plan being prepared by another organisation, and the relevant councillor provided an important link with, and voice for, the most affected section of the community. The council saw it as an important part of its role in the consultation process to give voice to that community and saw the particular councillor as critical to that process, even though the person was also potentially directly affected.

8.67
In general, we are happy to receive applications and to then ask the council staff or the affected councillor for any further information that we need. In practice, however, these issues tend to arise with some urgency because the potential conflict is often identified shortly before the meeting in question. When a decision is needed within a few days, it is helpful if the initial application is as comprehensive as possible.

Problems with the Act and the need for reform

8.68
In June 2005, the then Auditor-General published a discussion paper68 highlighting practical difficulties with the current Act and suggesting options for how it might be improved. We have reiterated our concerns about working with such an outdated Act a number of times since then, in our regular annual reports and reports on our work in the local government sector. In our view, the problems with the Act are increasing.

8.69
When we published the discussion paper in 2005, we suggested that the contracting rule could be repealed completely but that there may be benefit in keeping a revised version of the participation rule.

Problems with the contracting rule

8.70
Our concerns about the problems with the contracting rule were heightened during the 2007 local authority elections. Our Annual Report 2007/08 included the following comment:

We have recorded our view many times in recent years that the Act is in need of reform. It is poorly drafted, it operates unevenly, and the rationale for some of the requirements is unclear. Our experience with the 2007 local authority elections highlighted that the difficulties with the Act have practical consequences and can have a significant effect on the operation of the local democratic process. Resulting from the 32 requests for guidance that we dealt with, four people were either prevented or discouraged from standing as candidates because of the contracting rules in the Act, and two others had to rearrange their personal affairs to be eligible to be candidates. We remain of the view that the Act in its current form does little to strengthen democracy at the local level.

8.71
Our view now is that the contracting rule also adds a level of compliance cost to the sector because staff from our Office and from councils around the country regularly have to go through routine approval processes on standard matters. The $25,000 financial threshold has not been updated since 1982 and so more contracts now require approval.

Problems with the participation rule

8.72
Developments during the last two years now suggest that the participation rule is also becoming difficult to operate in practice. There is a risk that the Act applies blunt rules and cumbersome approval procedures to matters that require reasonably subtle and immediate judgement. Our decisions on Environment Canterbury are a good example of the complexity of the issues. We appreciate that others may consider that the approval processes and tests that the Act requires us to administer may not be the best way to manage potential conflicts of interest in situations of this kind. It is also questionable whether a criminal sanction is appropriate in this kind of situation.

8.73
The Act is out of step with the approach taken to managing conflicts of interest in governance bodies in the Crown Entities Act 2004 and other similar legislation in the state sector. In other sectors, the legislation may set out declaration requirements, and sometimes even rules on participation, but these are left to the entity to manage and administer. Failure to follow the requirements may result in breaches of duty to the organisation or political accountability of some kind. It is very unusual to have an independent third party making final decisions on who can and cannot participate and for the criminal law to be used as a penalty.

8.74
We also note that, in some situations, the financial interest regulated by the Act may be only part of the issue, and perhaps not even the major risk. The Act regulates only financial interests. It does not regulate more general conflicts of interest, which may arise as a result of other roles that the councillor has or their personal associations. We have discussed situations with council staff where there were significant concerns about a councillor's non-financial interests, and a marginal concern about the financial interests regulated by the Act. In those circumstances, it may give a misleading impression if we confirm that the Act does not prevent participation. Councillors can sometimes derive false comfort from such advice, and take it to mean that they are free to participate, when in fact their participation may still create general legal risks for the council's decision-making.

8.75
Finally, we note that the Act's rules and processes for decisions on participation are unwieldy in practice, and do not fit well with the complex consultation and decision-making requirements of the Local Government Act 2002. Again, the situation of Environment Canterbury provides a good example. The many different stages of the decision-making process – as the issue progressed from broad idea, to a concrete proposal, to consultation at various points, and finally to implementation and incorporation into budgets and plans – all required careful and specific consideration under the Act. This was time-consuming and complex for us, council staff, and the councillors concerned.

Progress on reform

8.76
The Department of Internal Affairs had begun to review the Act, based largely on the discussion paper we published in 2005. However, that review has not been a priority given the range of other legislative reforms that are currently under way in the local government sector.

8.77
The needs and practices of the sector have changed considerably since we published our discussion paper. The work that we have had to carry out under the Act has also changed during that time. In particular, problems with applying the participation rule in section 6 have become more apparent in recent years.

8.78
We are now of the view that it would be better to review the Act as a whole, from a first principles perspective. Its basic approach is out of step with other public sector legislation, and the practical difficulties and compliance costs of the current regulatory approach are becoming more acute.

8.79
We will continue to discuss these concerns with the sector, with Local Government New Zealand, officials, and the Minister of Local Government, as appropriate.

66: The most recent version is Guidance for members of local authorities about the law on conflicts of interest, June 2007.

67: Investigation into conflicts of interest of four councillors at Environment Canterbury, December 2009.

68: The Local Authorities (Members' Interests) Act 1968: Issues and options for reform, June 2005.

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