A recent decision in the High Court of New Zealand, Houghton v Saunders  NZHC 2229 , may provide helpful guidance to directors of Australian companies and their advisers when planning and undertaking ‘due diligence’ when preparing a prospectus and other disclosure documents in Australia.
The decision related to an action brought on behalf of shareholders of Feltex Carpets Limited (Feltex) against former directors and shareholders of Feltex and promoters of its 2004 initial public offering (IPO), for untrue statements contained the prospectus issued in relation to the IPO and listing on the New Zealand Stock Exchange, following Feltex being placed into liquidation.
That decision concerned s. 56(1) of the New Zealand Securities Act 1978 (Securities Act), which provides that certain persons are liable for a pecuniary penalty and may be required to pay compensation:
“for the distribution of…. [a] registered prospectus that includes an untrue statement…”
The Securities Act deems a statement to be ‘untrue’ if it is misleading in the form and context in which it is included, or if it is misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is included.
These provisions are the New Zealand equivalent to section 728 of the Corporations Act 2001 (Cth) (Corporations Act), which provides that directors and others may be liable if there is:
“a misleading or deceptive statement in a disclosure document….”
The crux of the Feltex matter was that the IPO prospectus contained various untrue statements, including in relation to, among other things:
- undisclosed adverse trends in Feltex’s recent trading history
- misstatements or omitted disclosure of certain risks facing Feltex’s business
- the use of misleading or unreasonable assumptions in predicting the future performance of its business for the coming financial years and the misleading presentation of historical and prospective financial data, which effected the manner in which certain quantitative data was presented in the prospectus.
Ultimately, the plaintiff’s claim, that the prospectus included untrue statements, were dismissed by the Court on the basis that, “while a number of the criticisms of the prospectus had some justification, none of them made out material misleading content or omissions that would trigger liability” .
Of note, however, were several comments made by Justice Dobson in relation to the ‘due diligence’ process that was undertaken when preparing the prospectus.
Although the Court was not required to specifically decide whether the ‘due diligence’ defence was available to the directors and others, as the Court had already found that the statements were not ‘untrue’ for the purpose of the Securities Act, the Court noted the thoroughness of the due diligence process undertaken when preparing the prospectus, suggesting that, even if the plaintiff’s claim had been successful, the directors and others would have been entitled to rely on the ‘due diligence’ exemption contained in section 56(3) of the Securities Act, which provides that:
No person shall be liable under subsection (1) of this section in respect of any untrue statement included in an advertisement or registered prospectus, as the case may be, if he or she proves that----
(c) as regards every untrue statement not purporting to be made on the authority of an expert or of a public official document or statement, he or she had reasonable grounds to believe and did, up to the time of the subscription for the securities, believe that the statement was true.”
While not identical to the Australian equivalent provision, in light of the limited judicial guidance in Australia as to the application of section 731 of the Corporations Act, the Court’s comments are of assistance to directors and their advisers when planning their due diligence processes, by providing helpful colour as to the level of detail that the Courts may consider regarding the due diligence process that has been undertaken and what may be required if the defence is to be available.
The Court expressed the view “that the due diligence process…appeared (without the benefit of comparison with any other processes undertaken for prospectuses at or around the same time) to be very thorough’’. That process included, among other things, the establishment of a formal due diligence committee, management interviews of 11 of Feltex’s senior managers (and written sign-offs on specific areas of responsibility from each), the preparation of a detailed due diligence report, legal advice as to the standard of discourse required and advice from an accounting firm as to, among other things, the manner in which the prospective financial information contained in the prospectus had been prepared and presented.
The judgement also confirmed the position that, while the directors were not required to conduct all relevant research personally, they must not rely blindly on information provided by others and must undertake a ‘genuine individual assessment of the accuracy of the content’ of the prospectus and must reasonably believe in the accuracy of the information presented so as to be able to rely on the due diligence defence.
As the plaintiffs have lodged an appeal against the decision, it may not be the final position as to whether the statements contained in the prospectus were in fact untrue, or not. However, as the due diligence process undertaken in the Feltex matter appears to be similar to that often undertaken in Australia, the decision provides helpful colour to Australian directors and their advisers as to the appropriateness of their own due diligence processes and the potential availability of the ‘due diligence defence’ in practise.