- With investor class actions against operators of failed managed investment schemes on the rise, it is increasingly important for scheme operators to ensure Product Disclosure Statements are not "defective". This includes ensuring that "significant risks" of holding financial products are adequately disclosed in Product Disclosure Statements.
- The Victorian Supreme Court and Court of Appeal’s decisions on the Timbercorp class action provide useful guidance to scheme operators on risk disclosure in Product Disclosure Statements.
Investors commencing class actions against operators of failed managed investment schemes on the basis of "defective" Product Disclosure Statements is becoming increasingly common. The rise in such class actions is not surprising given scheme operators, as issuers of the Product Disclosure Statements, are responsible under the Corporations Act for making careful and considered decisions as to the information disclosed in the Product Disclosure Statement – section 1013C of the Corporations Act requires scheme operators to judge the information, including information pertaining to "significant risks", that retail clients may reasonably require to make an investment decision. Disappointed investors and their legal advisors, with the benefit of hindsight, can perceive that the risks of investing in the scheme were inadequately disclosed in the Product Disclosure Statement – this is often a basis on which investor class actions are commenced.
An example of such is the class action against the Timbercorp Group by investors in the failed horticultural and forestry managed investment schemes operated by Timbercorp Securities Ltd (a member of the Timbercorp Group). This class action recently came to an end when the High Court refused investors leave to appeal, following the Victorian Supreme Court of Appeal's decision that the Product Disclosure Statements issued by Timbercorp Securities Ltd was not defective1. The decisions in the Victorian Supreme Court and Court of Appeal on the Timbercorp class action provide useful guidance to scheme operators on risk disclosure in Product Disclosure Statements2.
Key practical points
When preparing Product Disclosure Statements and considering the information about the "significant risks" of the scheme that should be disclosed, scheme operators should bear in mind the following:
- the probability of a risk occurring, along with the degree of impact on investors, are both factors to be considered when determining if a risk is a “significant risk” – emphasis should not be placed on the consequence of the risk without considering the probability of the risk occurring; and
- the ability of the scheme operator to manage the risk is relevant to determining if the risk is a “significant risk” requiring disclosure in the Product Disclosure Statement – the management of the risk affects the probability of the risk occurring.
The Timbercorp class action
Shortly after the Timbercorp Group went into liquidation, Mr Woodcroft-Brown, on behalf of himself and other investors in managed investment schemes operated by Timbercorp Securities Ltd, commenced proceedings in the Victorian Supreme Court alleging that the Product Disclosure Statements issued by Timbercorp Securities Ltd was defective as it failed to disclose the following "significant risks":
- ("structural risk") the risk that the Timbercorp Group may fail because of insufficient cash, as the Timbercorp Group's structure depended on its capacity to obtain and service external funding, scheme members not defaulting on payments, and being able to securitise loans; and
- ("adverse matters") the adverse matters that would have put the Timbercorp Group at a higher risk of failure, namely the global financial crisis' impact on the availability of credit, and the ATO announcement that investors in non-forestry managed investment schemes could no longer claim upfront deductions for contributions to such schemes.
The failure to disclose the above risks was alleged to be a breach by Timbercorp Securities Ltd of its obligation under section 1013C of the Corporations Act to disclose information about the "significant risks" associated with holding the financial product which a retail client would reasonably require to make an investment decision.
The trial judge found that the "structural risks" and the "adverse matters" did not require disclosure for the reasons outlined below. This decision was upheld by the Court of Appeal. The investors attempted to appeal to the High Court on this point, however the High Court refused leave to appeal.
The investors also alleged that the Product Disclosure Statements contained false and misleading statements. The investors failed on this ground at trial and on appeal for the reasons set out below.
Meaning of “significant risk”
Both the trial judge and Court of Appeal held that when assessing if a risk is a "significant risk", the probability of the risk needs to be considered along with the consequences of the risk – to determine “significant risks” based on the consequences of the risk without considering probability of the risk would be incorrect. The Court of Appeal further added that what constitutes a “significant risk” will involve considering a range of issues which will depend on the particular product and circumstances.
The trial judge found that the "structural risk" was not a "significant risk" as, at the time the relevant Product Disclosure Statements were issued, the evidence showed that there was no real threat to the Timbercorp Group’s cash flow, given it had the support of its bankers. Further, the Timbercorp Group did not have actual knowledge that its bankers may withdraw their support until well after the relevant Product Disclosure Statements were issued. The Court of Appeal agreed with the trial judge’s approach.
Management of a risk
The Court of Appeal endorsed the trial judge’s approach that the successful management of a risk could prevent the risk from being a “significant risk” which required disclosure in a Product Disclosure Statement. The Court of Appeal clarified that the fact the risk is capable of management does not prevent the risk from being a “significant risk” requiring disclosure – rather, the management of the risk should be considered with the likelihood of the risk occurring. Information about a risk that is being reasonably managed, despite the fact the risk can have significant consequences if not managed, is not information that an investor would reasonably require in a Product Disclosure Statement.
The trial judge found that the "adverse matters" were not "significant risks", as the Timbercorp Group were successfully managing the “adverse matters”. The “adverse matters” did not “crystallise” into real risks until the Timbercorp Group’s management realised these events could not be successfully managed, and the evidence showed that the management did not have this knowledge until the time the Timbercorp Group’s bankers withdrew their support. This approach was endorsed by the Court of Appeal.
False and misleading representations
The investors also alleged that the Product Disclosure Statements contained misleading and deceptive statements – the investors failed on this ground at trial and on appeal. The trial judge held that the alleged misrepresentations were not misleading as they were supported by reasonable grounds. Further, the trial judge made a finding that Mr Woodcroft-Brown had not relied on the Product Disclosure Statement in making the decision to invest, as the evidence showed his decision to invest in the scheme was mostly tax-driven. Scheme operators can take comfort that when determining reliance, the court will consider the extent of the reliance an investor puts on the Product Disclosure Statement when making the decision to invest, and not simply whether the investor or his financial advisor considered the Product Disclosure Statement.