Thursday 19th September 2019
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Is the liability companies and directors face for breaches of NZX's continuous disclosure rules preventing people from becoming directors?
Is the continuous disclosure regime dissuading a significant number of companies from listing on NZX?
Should offer documents for initial public offerings be permitted to omit financial forecasts?
The capital markets review's report suggests the answer to all three questions may be yes and has recommended at least a review of those policy settings.
It says the liability for breaches of continuous disclosure rules is "much stricter than many other prominent listed markets except for Australia."
The Australian Law Reform Commission noted the liability regime "appears to have been arrived at unintentionally" and has recommended a review, the report says.
Civil sanctions against companies that breach the disclosure rules range from fines imposed by NZX to legal liability that could result in fines and/or damages to affected investors.
"Importantly, there is no requirement to establish dishonesty or recklessness – or any other state of mind on the part of the issuer – to find a breach of the continuous disclosure regime," the report says. That's known as strict liability.
Litigants need to prove a degree of fault to extend their actions to cover a company's directors or executives. However, the report merely notes that directors may be liable as accessories.
It noted that a leading US class-action expert had observed that the lack of a fault element was a "particularly plaintiff-friendly aspect of Australia's continuous disclosure laws."
In Australia, alleged breaches of continuous disclosure obligations or allegations of misleading and deceptive conduct are the most common category of class actions pursued.
However, not a single case has been pursued through to judgment. Claimants opted to settle for sums ranging from A$3 million to A$132.5 million between 2013 and October 2018, with a median of A$36 million.
The ALRC report doesn't form any definitive conclusions as to whether the law should be changed but notes a wide range of views.
It's unsurprising that third-party litigation funders and others who work with them think even a review is "an unwarranted examination of a necessary and protective legislative regime."
Equally unsurprising, those who defend against class actions "express an urgent need to reassess" the regime.
"Somewhat counter-intuitively, a group of institutional investors ... expressed concern that some less meritorious class actions were being promoted by funders and lawyers, but were nevertheless adamant that there should be no watering down of the continuous disclosure obligations."
As for the Australian Securities and Investment Commission, it doesn't appear to hanker for any change.
"Continuous disclosure obligations are critical to protecting shareholders, promoting market integrity and maintaining the good reputation of Australia's financial markets," it told ALRC.
"The economic significance of fair and efficient capital markets dwarfs any exposure to class action damages."
Chapman Tripp partner Roger Wallis says New Zealand’s regime evolved over time, from continuous disclosure being part of a private contract with NZX to the early 2000s when there was a push to give the Securities Commission greater powers to pursue insider trading. The current rules were codified through the 2013 Financial Markets Conduct Act.
Wallis is in favour of a review. He says there's no right or wrong answer as to where the balance should lie, but that it's clear the New Zealand and Australian regimes stand out as setting more stringent standards for companies and directors, making litigation easier for regulators and aggrieved investors.
The ALRC report compared Australia’s rules to those in Britain, Wales and Canada.
In England and Wales, claimants have to establish that conduct was reckless or dishonest – mere incompetence isn't sufficient. ALRC says this approach "reflected a deliberate policy choice to reduce the burden of opportunistic litigation."
Canada went a step further to discourage the types of lawsuits common in the US with "a screening mechanism."
Litigants need to gain court approval by demonstrating their proposed action is brought in good faith and that there is a reasonable possibility they will win at trial.
The framers of the legislation specifically wanted to minimise "unmeritorious litigation."
Despite a mini-industry of litigation funded by specialised third parties springing up in Australia, New Zealand examples are few and far between.
LPF Group – it stands for level playing field – has funded 15 cases since 2010 and achieved more than $100 million in awards to plaintiffs. But only one case, the ongoing Mainzeal saga, was against a listed company, and that was brought long after the firm left the NZX.
"There have been very, very few cases. I can't even think of a case where there's actually been a collect" against a listed company, says LPF founder Phil Newland.
Feltex is the one high-profile case involving a prospectus forecast. It’s back in court in November, 15 years after the company collapsed.
A planned suit against South Canterbury Finance shows one reason why these cases are few and far between – it couldn’t attract backing because the economics didn't stack up.
Nevertheless, insurance premiums for directors' and officers' insurance have gone through the roof.
S&P/NZX 50 companies reported recent premium increases of more than 300 percent, according to the capital markets review, and evidently so have deductibles.
Financial Markets Authority chief executive Rob Everett says he's willing to have a discussion about the liabilities imposed with the continuous disclosure regime, "but I think our starting point would be similar to ASIC."
Everett notes that "New Zealand doesn't have a history of overly aggressive lawsuits in this space."
One reason is that, until now, New Zealand has taken an "opt-in" approach, meaning all potential litigants have to sign on to a particular action.
However, the Court of Appeal this week ruled in favour of an "opt-out" approach for homeowners suing Southern Response Earthquake Services.
"In most cases, there will be compelling access to justice reasons for making an opt-out order. It is not necessary or appropriate to wait for detailed legislation about class actions to be enacted before the court is willing to make such orders," the Court of Appeal said.
Wallis says directors are making judgements, working with imperfect information, often in very complex circumstances, such as when information might be held in a different arm of an organisation rather than at the parent board level.
A good example is Fletcher Building. It wasn't until about September 2016 that then chief executive Mark Adamson first became aware he had a major problem brewing in the company's construction division and apparently didn't become aware of the full extent of the problem until about the time he was fired in July 2017.
More than half of the near-$1 billion of losses from the construction division were provisioned after Adamson left. In that case, one could argue that delay had been because Adamson hadn't wanted to hear bad news.
Wallis – and the report – says the emphasis on continuous disclosure may be making boards more conservative and distracting them from working on their companies' strategies.
"I think the risk is real" of boards becoming too cautious. "This is a classic area where the balance may have shifted too far," he says.
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