Continuous disclosure in the spotlight
Continuous disclosure is again in the spotlight with the High Court of Australia handing down its decision on Tuesday in the long running dispute between the Australian Securities and Investments Commission (ASIC) and Fortescue Metal Groups Limited (FMG) and its former CEO (and current Chairman), Mr Andrew Forrest.
The High Court held that FMG had not misled investors in communicating to the market that it had entered into "binding" agreements with Chinese companies to build a mine, port and railway. The Full Federal Court (Full Court) had earlier ruled that these announcements were misleading because they conveyed to the investing public that the agreements could be legally enforced in an Australian Court, when that was not the case.
In reviewing the decision of the Full Court, the High Court asked two key questions. These were:
- first, what did the communications convey to the intended audience (investors)?
- second, was this message misleading?
In answering these questions, the High Court reached the contrary conclusion to the Full Court. It found the announcements conveyed a message about what the agreements said, not a message about the legal enforceability of those agreements. That is, because the agreements stated that they were "binding", and the parties to the agreement understood them to be binding, the message conveyed was not misleading.
As the High Court found that the communications were not misleading, it was not necessary for it to rule on other important findings from the earlier Full Court decision, namely that:
- misleading market disclosures, when uncorrected, could trigger breaches of the continuous disclosure rules and directors' duties; and
- the business judgement rule was not a defence to a breach of directors' duties in this context.
How does this ruling impact best practice for market disclosures and communications?
Market disclosures is a difficult and complex area. This is demonstrated by the fact that, while FMG and Forrest were eventually exonerated, both were first subjected to protracted and expensive proceedings which included, in Mr Forrest's case, facing the possibility of disqualification as a director. These considerations as well as the High Court's findings and the issues still remaining unresolved highlight the ongoing need for listed companies and their officers to:
- have in place effective and robust continuous disclosure policies, which emphasise conservative and timely disclosure practices;
- regularly monitor compliance with those policies;
- carefully consider what a disclosure conveys and how it will be understood by the intended audience, which is usually the investing public. The subjective intention of those making the statements is irrelevant. The High Court has signalled that it will assess market disclosures by reference to a target audience comprising all investors, not only sophisticated ones. As a result, companies and their officers need to consider what would be conveyed to an "ordinary and reasonable" member of that audience;
- where possible, first test the messages that are conveyed by a proposed market release by passing it to persons who are a step removed from the underlying negotiation, such as external counsel or the investor-relations team;
- when announcing a significant contract or transaction (including one that contemplates more detailed agreements to be entered into), decide whether or not to disclose the full terms of the agreement itself. There will often be reasons militating against full disclosure of these terms, such as confidentiality and commercial sensitivities. Where the full terms are not disclosed, you must identify and disclose price sensitive terms. This requires careful consideration of which terms the intended audience would consider price sensitive. Where there is doubt, it is usually preferable to err on the side of caution. Be aware that a disclosure can be misleading by omission; for example, if an agreement is subject to conditions or entry into a further agreement, this should normally be disclosed;
- be alive to the "substance over form" principle that underlies the disclosure rules. If an investor would ordinarily expect to see a particular term disclosed, then this should occur;
- following the James Hardie decision which considered similar issues, ensure that the minutes of any board meetings at which key transaction documents and/or market disclosures are discussed accurately record all issues considered;
- promptly correct any disclosures that are subsequently identified to be mistaken; and
- not go beyond what you are prepared to state in a market announcement when conducting interviews, roadshows and analyst briefings.
What was the case about?
In late 2004 and early 2005, FMG (or Forrest on its behalf) made a series of ASX announcements, presentations and interviews stating it had entered into "binding" build and transfer agreements with three Chinese companies for the construction, financing and transfer of mine, rail and port infrastructure for its iron ore project in the Pilbara (Framework Agreements). The Framework Agreements included clauses to the effect that the agreements would become binding upon approval of the relevant boards, and that although each Framework Agreement was "an agreement in itself" a fuller and more detailed agreement not different in intent would be developed later.
A newspaper article was subsequently published in early 2005 claiming that the Framework Agreements did not impose any legally binding obligations on the parties, as despite stating they were binding on both parties, they left issues relating to scope of work and price to be decided at a later stage.
What guidance does the High Court decision provide in relation to whether announcements will be found to be misleading?
The High Court decision provides the following guidance in relation to how the Courts will approach determining whether any public statement is misleading or deceptive:
- in determining whether a statement is misleading, a Court will ask, (1) what is the message that is conveyed to the intended audience? and (2) is that message misleading or deceptive?
in determining what message is conveyed, a Court will:
- look at the whole of the statement in context;
- consider the effect of the statement on the intended audience, and not what the person making the disclosure may have intended to convey. In this case, the intended audience was present and possible future investors and, perhaps, some wider section of the commercial or business community;
the Court will also:
- have regard to the nature of the parties involved in the relevant transaction. In this case the fact that three parties to the Framework Agreements were state-owned entities of the Chinese government was relevant to the ultimate finding that the message did not convey anything about the enforceability of the Framework Agreements in Australian Courts;
- look at the surrounding factual context of the announcement. In this case, the High Court found that the statement that "binding agreements" had been entered into only conveyed a message about what the agreements said, not whether those contracts were legally enforceable in Australia. However, the High Court also specifically mentioned this will not always be the outcome, even if those same words are used in another announcement. For example, where an agreement is struck between two Australian companies, a statement that this agreement is "binding" could potentially be found to contain a representation that it is enforceable in an Australian court.
How does the High Court decision affect the Full Court's reasoning on continuous disclosure obligations?
The High Court decision overruled the Full Court on the key question of whether or not the releases were misleading. Because the High Court decided that FMG did not mislead or deceive the market, it did not consider the continuous disclosure and directors' duties points considered by the Full Court.
The Full Court had held that once misleading statements are made to the market, the continuous disclosure provisions in the Corporations Act require that they be corrected. While it considered that the Corporations Act does not expressly impose an obligation to correct information already provided to ASX, in this case the corrective information itself was material price sensitive information (because it would affect investors' confidence in FMG's management) and therefore had to be disclosed. So the Full Court concluded that failure to correct misleading statements promptly is a breach of those continuous disclosure provisions.
The Full Court had also held that where an officer (in this case, Mr Forrest) knowingly participated in the breach, the officer was also in breach of his duty to act with care and diligence. Further, the business judgement defence was not available to Mr Forrest in these circumstances, because the decision not to make accurate disclosure was a decision whether to comply with the law, and not a business judgement at all.
Click here to view a diagram that summarises the chain of reasoning adopted by the Full Court.
Therefore where announcements are found to be misleading or deceptive companies still risk also being found liable for breach of their continuous disclosure obligations and directors are still at risk from proceedings for breach of their directors duties which can result in disqualification.
While the High Court decision was favourable to FMG and Mr Forrest, the time and cost expended on the litigation was undoubtedly considerable, and the negative impact of allegations hanging over companies and their directors for such a lengthy period cannot be underestimated.
In the current challenging market environment there are an ever increasing number of investor class actions against companies and their directors for alleged misleading disclosures. ASIC also has powerful enforcement tools at its disposal following alleged continuous disclosure breaches, most notably enforceable undertakings (such as a periodic audit of a company's continuous disclosure practices) and infringement notices.
In fact, even before this decision was handed down, we have observed a recent growing trend for ASIC to use the infringement notice regime for not simply failures to disclose material price sensitive information in a timely manner, but in respect of misleading disclosures as well. The negative publicity surrounding the use of either of these sanctions can cause considerable damage to a company's reputation.
All this reinforces the need for companies to have robust continuous disclosure policies in place, to regularly review those policies and monitor compliance with them, to make every effort to ensure that both timely and accurate disclosure is made to the market of material developments. If a misleading disclosure is inadvertently made, then this must be promptly corrected once identified.
In this respect, the ASX has indicated that it intends to release imminently an updated draft Guidance Note 8 on Continuous Disclosure for public consultation. It is anticipated that this Guidance Note will provide guidance to companies having regard to the Fortescue decision.