In the past year a trilogy of failed finance company cases have come before the New Zealand courts, providing important reminders and lessons for directors as they seek to comply with securities laws and their duties as directors.
All three cases involved charges against directors of finance companies for defective disclosures in offer documents under section 58 of the Securities Act, and one case also involved charges of making false statements under the Crimes Act and the Companies Act.
For Bell Gully commentary on these cases, see our earlier articles:
- Further clarity for directors' duties: The Moses case and the Steigrad case (aka Nathans and Bridgecorp) which discusses the convictions against the directors of Nathans Finance Limited under section 58 of the Securities Act for issuing offer documents containing untrue statements;
- The Lombard decision: more important lessons for directors which discusses the convictions against the directors of Lombard Finance & Investments Limited under section 58 of the Securities Act for disclosure breaches in relation to an amended prospectus and three investment statements issued in December 2007; and
- The Bridgecorp decision – more convictions for defective disclosures which discusses the liability of Bridgecorp Limited's directors under the Securities Act, the Crimes Act and the Companies Act for defective disclosures in offer documents issued in December 2006, six months before Bridgecorp collapsed.
What should directors take-out from these cases?
In brief, some key take-outs for directors arising from these cases include:
- Strict liability offence but subject to materiality and due diligence defence: Directors may be criminally liable under section 58 of the Securities Act even if they acted honestly and were not reckless. The offence is a "strict liability" offence, with no form of mental intent required. However, this does not mean that if an offer document contains an untrue statement, the directors must be convicted, as one commentator has asserted. 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.
- Disclosure of all material information: Offer documents must disclose "everything of relevance that is likely to be material to the investment decision".
- The prudent but non-expert investor: The target audience for offer documents is a "prudent but non-expert person". Such an investor includes someone who understands technical words and financial jargon, but who may have "less than a complete understanding of all content" and who may not seek financial advice.
- Exercise own judgment: Directors' obligations in relation to the accuracy of the content of offer documents are non-delegable. Directors ultimately must exercise their own judgment about the documents.
- Reliance on management: Although directors can generally rely on information provided by management, they must adequately monitor and test the competence of management, and question the advice of management where they have other information that should put them on inquiry.
- Absence of red flags is no excuse: Directors cannot rely on the absence of any red flags raised by professional advisers in substitution of their own duty to review the offer documents.
- Timely and proper review required: Directors must ensure that they receive draft offer documents in sufficient time to properly review them (this is consistent with Australian case law: see our article Directors' Liability for Mistakes in Financial Statements).
- Securities Act prevails: If there is a tension between downplaying risk to protect existing investors and shareholders and complying with the Securities Act, the Securities Act prevails.
Further judicial guidance on the horizon
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.