In the latest criminal case against the directors of a failed finance company for defective disclosures in offer documents, directors of Bridgecorp Limited were found guilty this month of offences under the Securities Act, Crimes Act and Companies Act: R v Petricevic [2012] NZHC 665 (the Bridgecorp decision).

Justice Venning applied the same principles set out in the earlier Nathans Finance and Lombard Finance decisions to the Securities Act charges in the Bridgecorp decision, but there are two distinguishing aspects of the Bridgecorp decision which provide further guidance for directors:

  • One of the non-executive directors successfully defended some of the Securities Act charges on the basis that he reasonably relied on management reports. Neither the Nathans Finance nor Lombard Finance directors successfully established this defence.
  • The two executive directors were convicted of making false statements under the Crimes Act and Companies Act – charges that were not laid by the Crown in the Nathans Finance and Lombard Finance cases.

In this update, we focus on these two aspects of the case. For a summary of the key lessons for directors as they seek to comply with securities laws and their duties as directors, see our earlier update The Lombard decision: more important lessons for directors.

Background

Bridgecorp borrowed money from the public to finance property developments. By the time that receivers were appointed in July 2007, Bridgecorp had $459 million of secured debenture stock outstanding, and its subsidiary BIL had $29 million of capital notes outstanding. The secured debenture stock holders are expected to receive less than 10 cents on the dollar, and noteholders will likely recover nothing.

Securities Act charges

The charges under the Securities Act related to prospectuses and investment statements issued by Bridgecorp and BIL on 21 December 2006, six months before Bridgecorp collapsed.

Under section 58 of the Securities Act, the Crown was required to prove beyond reasonable doubt that:

  • each offer document included an untrue statement (such as a misleading statement or material omission);
  • the offer document was distributed; and
  • the director signed the prospectus or was a director at the time of distribution of the investment statement.

This is a "strict liability" offence, which means that the Crown is not required to prove that the directors were dishonest or reckless, or had any other form of mental intent. However, the directors have a defence if they prove, on the balance of probabilities, that the misstatement or omission was immaterial, or that they believed – and had reasonable grounds to believe – that the statement was true.

The untrue statements

The court found that the offer documents distributed in December 2006 contained the following misleading statements or material omissions:

  • The offer documents stated that a $76 million loan was made to an unrelated party, when that party was in fact ultimately owned and controlled by Bridgecorp and one of its directors.
  • The offer documents stated that there had been no change in Bridgecorp's financial circumstances since June 2006, when in fact new investments had declined significantly, impaired loans had more than doubled and actual collections were 20% of forecast.
  • The offer documents stated that Bridgecorp managed liquidity by maintaining a minimum cash reserve with a bank, when in fact no cash reserve was held.
  • The offer documents failed to state that Bridgecorp's liquidity position had deteriorated since June 2006.
  • The offer documents stated that Bridgecorp never missed an interest or principal payment to investors, when from February 2007 Bridgecorp regularly missed such payments. Although the offer documents were correct in this particular when first distributed in December 2006, they became untrue in February 2007, and should have been withdrawn.

The directors' defence

The court found that the executive directors, Petricevic and Roest, did not have a genuine and reasonably held belief that the statements referred to above were true. They were convicted on all counts under the Securities Act.

However, the position was different for the sole non-executive director to face trial, Steigrad. The court ruled that "directors are not relieved of their obligation to check or question the advice of management where they have other information that should put them on inquiry. If there is such information available to them, they are not entitled to put it to one side and accept the line by line sign off or management report without question." Instead, the director is "obliged to raise the issue, test the response and consider in light of all the information he or she then has what further steps may be appropriate or required."

The court found that as at December 2006, there were "no particular highlights" in any of the board information provided to Steigrad to put him on notice and require further inquiry. Steigrad was entitled to rely on the "reassurance" of management reports, and was found not guilty of the charges as at December 2006.

However, there was a "tipping point" in March 2007, by which time Steigrad had sufficient information to put him on inquiry. For example, the board papers referred to an actual negative cash position of $3 million, compared to a positive forecast of $33 million, and management was forecasting further negative cash flow. Steigrad failed to follow up, and the court therefore found that he did not have a reasonably held belief as at March 2007 that the statements in the offer documents were true.

Crimes Act and Companies Act charges

The executive directors, Petricevic and Roest, were also charged with making false statements under the Crimes Act and the Companies Act, which carry a maximum penalty of 10 years in prison. The Crown alleged that the offer documents and two directors' certificates falsely stated that Bridgecorp had never missed an interest or principal payment when due. In fact, Bridgecorp missed payments on 55 separate occasions between February and June 2006.

Unlike the Securities Act charges, the Crown had to prove that Petricevic and Roest knew that the statements were false, or were reckless as to whether the statements were false.

Petricevic gave evidence that he first learned of the missed payments in the newspaper after receivership. However, three members of the senior management team, as well as Roest, all testified that they had discussed the defaults with Petricevic before receivership, and board reports also identified the issue. Venning J concluded that Petricevic's evidence "is just not credible."

Roest testified that the payments were not missed but delayed, that the problem could have been solved by writing cheques instead of paying by direct credit, and that investors implicitly accepted the delays. Venning J rejected these arguments, ruling that Roest's evidence was "simplistic and misconceived", "unrealistic and contrived", and "specious."

Petricevic and Roest were convicted on all charges of making false statements under the Crimes Act and Companies Act.

Comment

The remaining two directors, Davidson and Urwin, had earlier pleaded guilty. Davidson was found not to have acted dishonestly and was sentenced to home detention, community work and ordered to pay $500,000 in reparations. Urwin, by contrast, was sentenced to two years in prison, despite his guilty plea.

The level of offending in Bridgecorp is clearly at the opposite end of the spectrum from the Lombard Finance case. In contrast to the Lombard directors, who were sentenced to community work and to make reparations, we expect that Petricevic and Roest will face lengthy prison sentences.

Finally, the Bridgecorp decision will not be the last word on directors' obligations under the Securities Act. The Lombard directors have announced that they are appealing both their convictions and sentence, giving the Court of Appeal an opportunity to weigh in on the principles applied by the High Court in the Nathans Finance, Lombard Finance and Bridgecorp cases. In addition, although the directors of Hanover Finance are not facing criminal charges, the FMA has brought a civil claim against the Hanover Finance directors under the Securities Act in relation to alleged defective disclosures in that company's offer documents.