Expanded liability under the continuous disclosure regime

The Securities Legislation Bill passed in late 2006 introduces a raft of changes to the securities regime including a wider ambit for imposing liability under the civil and criminal penalty provisions. In this article, senior associate Anna Buchly highlights how these new provisions affect the continuous disclosure regime and, using some recent cases as examples, provides some guidelines for ensuring that public issuers and their officers are not inadvertently subject to increased liability for non-disclosure when the new provisions come into force.

On 12 October 2006, the Securities Markets Amendment Act 2006 (the SMAA) was enacted¹. The SMAA will introduce substantial amendments to the Securities Markets Act 1988 (the Act), including the new insider trading and market manipulation regimes which have been discussed in previous issues of Commercial Quarterly.²

One area that will remain relatively unchanged by the SMMA is the continuous disclosure regime implemented by the last round of securities law reform in 2002. This provides for the on-going timely release of price-sensitive information by public issuers to the market in order to retain a level playing field for market participants dealing in their securities. However, making a decision about when to disclose under this regime may become even more complex after the SMMA is implemented because getting it wrong will not only have consequences for the disclosing entity but also the directors, officers and other individuals responsible for making the decision.

Extended definition of "contravene"

Under the current regime, the Act provides a number of statutory consequences for non-compliance by public issuers of the continuous disclosure requirements. The remedies, however, are directed only at breaches by the public issuer and not at the individuals responsible for ensuring that the public issuer has complied with its continuous disclosure obligations. When the SMAA comes into force, this will no longer be the case.

Under the SMAA, remedies for contraventions of the continuous disclosure requirements (and other provisions of the Act) have been incorporated in a new Part 5 of the Act. The SMAA extends the definition of "contravene" in this Part of the Act to include "aiding, abetting, counselling or procuring any other person to contravene" the relevant provision of the Act. This means that when the amendments are in force individuals involved in a public issuer's failure to comply with the continuous disclosure regime can be held personally liable for the public issuer's contravention of the continuous disclosure regime, subject to a due diligence defence discussed below.³

Remedies for contravention

The remedies for contravention of the continuous disclosure obligations contained in Part 5 of the SMAA include:

• the Securities Commission making a disclosure order requiring a person to make disclosure in accordance with the Act;

• the court, on application by the Securities Commission or any other person, granting an injunction restraining a person from engaging in conduct that constitutes or may constitute a contravention of the continuous disclosure obligations;

• the court, on application by the Securities Commission or any other person, making a disclosure order requiring a person to make disclosure in accordance with the Act;

• the court making, on application by the Securities Commission, a pecuniary penalty order and declaration of contravention; and

• the court, on application by the Securities Commission or any other person, making a compensatory order.

Pecuniary penalty orders and compensatory orders

Of particular concern to individuals caught by the expanded definition of a contravention of a continuous disclosure obligation will be the possibility of being subject to a pecuniary penalty order or compensatory order by the court.

In deciding whether to make an order that the person pay a pecuniary penalty to the Crown, the court must make a declaration of contravention and in doing so must be satisfied that the contravention:

• materially prejudices the interests of persons acquiring or disposing of securities; or

• materially prejudices the public issuer or its shareholders; or

• is likely to materially damage the integrity or reputation of any of New Zealand's securities markets; or

• is otherwise serious.

The maximum amount of any pecuniary penalty in respect of a breach of a continuous disclosure obligation or exemption has been increased from $300,000 to $1,000,000. In contrast with other jurisdictions with similar provisions, this figure applies regardless of whether the penalty is applied to the public issuer itself or an individual.

A declaration by a court of a breach of a continuous disclosure provision also enables a person who has suffered or is likely to suffer loss or damage because of the contravention to seek a compensatory order in respect of such contravention. A court can make a compensatory order to compensate an aggrieved person in whole or in part for the loss or damage suffered as a result of such contravention. However, in contrast to a pecuniary penalty order, there is no cap on the monetary sum which can be awarded under this type of order.

There is, therefore, the potential for the new enforcement and remedy provisions to have serious implications for directors, executives, advisers and other individuals involved in the management of public issuers.

Due diligence defence

In recognition of this, the Government has provided for a new due diligence defence to a contravention of the continuous disclosure provisions under section 19PA of the Act. This defence is similar to the defence provided in Australia under sections 674(2B) and 675(2B) of the Corporations Act 2001.

The defence provides that a person will not be liable in relation to a contravention by a public issuer of a continuous disclosure obligation if that person proves on the balance of probabilities that:

• they took all steps (if any) that were reasonable in the circumstance to ensure that the public issuer complied with its continuous disclosure obligations; and

• after doing so, that person believed on reasonable grounds that the public issuer was complying with its obligations.

In practical terms, establishing an adequate due diligence defence will depend, to a large extent, on the effectiveness of a company's policies and procedures to ensure appropriate continuous disclosure. But even then the complexities involved in complying with the continuous disclosure regime mean that it is not always going to be easy to get it right. This is perhaps best illustrated by the facts of the following two recent cases.

Riley v Jubilee

In Riley v Jubilee Mines,⁴ the Supreme Court of Western Australia considered whether it was reasonable for the senior managers of a company not to disclose to the market certain information which had no direct impact on the company's operations, but would nonetheless have a speculative effect on the company's share price.

BACKGROUND

In 1994, Jubilee received a letter from Western Mining Corporation (WMC) advising the company that WMC had inadvertently drilled on one of Jubilee's mining tenements. The WMC letter was accompanied by the tenements drill results, which suggested the possible presence of nickel within that tenement. Jubilee's senior management met to discuss the matter and subsequently held a meeting with WMC to discuss the possibility of exchanging tenements. The matter, however, never progressed beyond this point nor did Jubilee's senior managers disclose the drill results to the company's non-executive directors or to the market.

In 1996, WMC contacted Jubilee again to discuss the tenement. Following that meeting, the new managing director of Jubilee announced the 1994 drill results to the ASX. Jubilee's share price rose by nearly 10% following that announcement.

THE CAUSE OF ACTION

The case was brought on behalf of the former managing director of Jubilee who, not having been made aware of the WMC drill results in 1994, sold all his shares in the company before the 1996 market announcement. The plaintiff argued that the failure to announce the drill results in 1994 was a negligent breach of the company's continuous disclosure obligation and claimed damages based on the differential loss suffered by him.

THE DECISION

In deciding the case, the Australian Court noted that Jubilee had a number of reasonable explanations on why the WMC drill results were not disclosed back in 1994. In particular, the court noted that at the time of receiving the WMC drill results, the company had primarily dealt with gold exploration and had no interest in nickel exploration. The court also noted that Jubilee had limited financial resources at that time which prevented the company from capitalising on the information provided by WMC. Nevertheless, despite noting these factors, the Australian Court upheld the plaintiff's claim.

The Australian Court found that the share market for the company consisted primarily of investors seeking to extract short term capital gains. In such an environment, speculative information that would be insignificant to another company could have a significant impact on Jubilee's share price. The Australian Court concluded that the failure by Jubilee's senior managers to appreciate the drill results and to follow up on the matter constituted negligence on the part of the company. Accordingly, the Australian Court awarded Jubilee's former executive director the damages sought.

The decision in Jubilee establishes that any steps taken to ensure compliance with a public issuer's continuous disclosure obligations will necessarily have to include an appropriate assessment and determination of the materiality of the information to the price of the issuer's listed securities. A public issuer's internal policies should ensure that an assessment of materiality is made at an appropriate level within the organisation.

Auckland International Airport Limited v Air New Zealand Limited ⁵

Under statute, Auckland International Airport Limited (AIAL) has the power to set airport charges after it has consulted with its substantial customers. As part of this consultation process, AIAL provided confidential pricing information to Air New Zealand Limited (Air NZ). The pricing information was provided subject to the terms of a confidentiality deed between AIAL and Air NZ.

Air NZ advised AIAL that it intended to disclose the pricing information to the market in accordance with the continuous disclosure regime in the NZSX Listing Rules. Air NZ's view was that the confidentiality deed permitted disclosure of confidential information if disclosure was required by a relevant stock exchange listing rules. AIAL applied to the High Court for interim and permanent injunctions restraining disclosure on the grounds of anticipatory breach of contract and confidence.

The High Court held that the confidentiality deed only permitted disclosure where a party had given specific notice of disclosure to the other party and certain other requirements were complied with. The High Court held that Air NZ had not given maximum notice of disclosure practicable in the circumstances as required by the confidentiality deed.

The High Court ordered Air NZ not to disclose the pricing information. The High Court held that all of the conditions of the confidentiality exception to the continuous disclosure regime contained in the NZSX Listing Rules had been met and Air NZ was entitled to withhold the pricing information from the market.

Practical steps for action

Perhaps the main lesson to be learnt from these cases is, as the court observed in Jubilee, "if there is any doubt whether information is material, then the company ought to err on the side of caution to make the release".⁶

Of course, as noted earlier, this assumes that there is a suitable system in place to deal with identifying information which could be subject to the continuous disclosure requirements.

We would recommend that, in light of these recent decisions and the amendments to be made to the continuous disclosure regime through the SMAA (which could put you personally at risk), senior management of public issuers consider the following action points:

• Review the public issuer's communication policies to ensure clear responsibilities for continuous disclosure and identification of price sensitive information have been established.

• Ensure senior management are aware of and understand the public issuer's continuous disclosure obligations and their potential personal liability.

• Ensure that an appropriately qualified compliance officer is appointed who senior management can report any material concerns regarding continuous disclosure and who will internally investigate whenever appropriate disclosure has been made.

• Ensure that regular reviews of the public issuers continuous disclosure and communication policies are undertaken.

• Maintain records in order to establish a due diligence defence if the public issuer's internal policies fail, resulting in a breach of the continuous disclosure provisions.

• Check that the new personal liability under the amendments made by the SMAA will be covered under any Directors and Officers Liability Insurance policies.

¹ The SMMA will come into effect on a date to be appointed by Order in Council. The regulations for the new laws are expected to be signed by the Governor General in October and the new law should come into force at the end of the year.

² See in particular, the Spring 2006 issue of Commercial Quarterly.

³ A similar (although arguably clearer) position exists in Australia under sections 674(2A) and 674(2B) of the Corporations Act 2001.

⁴ [2006] WASC 199 SC (WA)

⁵ [2006] 3 NZCCLR 382 (HC)

⁶ See clause 312 of the Jubilee decision

Enquiries and information

For more information on any of the cases, articles and features in Commercial Quarterly, please email Diane Graham or call her on 64 9 916 8849.