The most significant reform of securities law in a generation moved a step closer recently, when the Commerce Select Committee (Committee) reported back on the Financial Markets Conduct Bill (Bill).
The key changes in the Bill recommended by the Committee are well summarised in the commentary to the Bill (which can be found here).
The report follows a focused consultation process, with 62 formal submissions made, including one from Simpson Grierson. While many areas of concern highlighted in the submissions have been addressed, certain key areas of concern remain.
In this FYI we focus on the core areas of civil and criminal liability.
A "Two Part" Civil Liability Regime
Civil liability refers to compensation payable to individuals that sue, and "pecuniary penalties" payable to the Crown at the instigation of the regulators (primarily, the Financial Markets Authority). This type of liability is distinct from criminal liability; ie you can have civil liability under the Bill without committing a criminal offence.
Now, even more clearly than before, the Bill separates its treatment of civil liability into two distinct regimes:
- one for contravening core offer disclosure obligations; and
- one for all other non-criminal contraventions.
The Bill also treats those with the primary obligation to comply (eg issuers) and their directors differently to others with 'involvement' in a contravention (eg employees, advisers and experts).
The table below provides an overview of the two civil liability regimes under the Bill, the persons affected and the defences available to those persons:
Click here to view the table.
Although, on its face, the system looks sensible, we see some real problems with it:
Broad Capture: The Bill originally used an extremely broad definition of "contravention" to capture persons who could be liable for civil pecuniary penalties and compensation arising out of a breach. The Bill has now separated the concept of contravention out into persons primarily in contravention and persons "involved" in a contravention, so distinct defences can be provided for each category (as set out above).
We are still concerned that the very broad elements of the original definition of contravention have been retained in the "involved" concept, including persons who are "directly or indirectly knowingly concerned in, or party to, the contravention".
In our view, this still stretches the net of civil exposure too widely, as it is apt to capture employees and professional advisers in their normal roles. Who will be prepared to get involved in those difficult judgement calls on the due diligence committee for an offer, with the potential that a wrong call could expose you to liability to all investors in the offer? There is a real risk that the effect of the reforms will be to limit public offerings to very large scale managed funds, which can afford the investment in systems and processes (and the implicit cost of "promoter"-style insurance for professional advisers) needed to cope with a vastly extended liability net.
In its commentary the Committee does make statements designed to allay concerns about the scope of liability risk for emplopyees and advisers. The reality is that the Committee has not recommended any substantive amendments that address the issue for employees or advisers involved in offers of financial products.
Automatic Director Liability: In our submission we noted that the effect on directors of a civil claim could be very serious, taking years out of their lives as they worked on proving defences to protect their reputations. For this reason we resisted the concept of automatic director liability (deemed contravention) in the case of contravention by an issuer.
Unfortunately this concept has been retained, and directors will automatically be in contravention of core offer disclosure provisions if the issuer is found to be in contravention. As a result, the defences become ever more important - and thankfully there is some good news here.
Defences to Civil Liability: The Bill now includes effective due diligence defences for parties primarily in contravention (see above). Previously there were none. In addition, the director's due diligence defence (for core offer disclosure contraventions) has now been clarified so a director may rely on the issuer's collective due diligence exercise (assuming their appropriate involvement). The standard required to make out the defence is that the director "took all reasonable and proper steps to ensure that [the issuer] complied". This is an improvement, as previous drafting implied that each director would need to conduct their own due diligence in order to be able to avail themselves of a defence.
Also, there is a new defence in relation to breach of the core offer disclosure provisions (ie for false statements in offer documents) of believing statements were not false and misleading, after making "all inquiries (if any) which were reasonable in the circumstances". This carries forward the primary "due diligence" defence available in the current Securities Act 1978.
Presumption of Causation: The Bill still contains a provision which deems the decline in value of a financial product to be caused by any breach of the core offer disclosure provisions, unless the contrary is proved. Although it has been redrafted to suggest that the presumption goes to causation only, and the Court is to determine compensation as it thinks just, it is still of concern to issuers. In effect, they will be put in the position of having to show that other relevant factors in the market have led to investor loss (if that is the case), rather than the investor having to prove that the breach caused their loss.
The criminal provisions relating to issuers remain largely unaffected in the new Bill, but a new provision has been introduced dealing with the criminal liability of directors for issuer contraventions. This is an improvement upon the previous provisions since it more clearly sets out that, in order for a director to be found criminally liable, it must be shown that not only has the issuer contravened but, in addition, that:
- the relevant product offer took place with the director's authority, permission or consent; and
- the director had knowledge or was reckless in relation to the contravention (eg as to whether a statement was misleading).
A new general criminal offence has been added to the Bill, for making or authorising misleading statements in a document required by the Bill, knowing that they are misleading, based on a similar provision in the Companies Act 1993. This will significantly increase responsibility levels around compliance - employees take note.
The latest time at which the provisions of the Bill will come into force is now set at 1 April 2017 (rather than 1 April 2015). We expect that most activity regulated by the Bill will become subject to the new provisions before this final date.
It is therefore important to start developing an understanding of the Bill and the application of the transitional provisions to your circumstances. There may also be advantages to you in transitioning to the Bill from the old law earlier than you are obliged to.
It is still possible to lobby for changes to the Bill while it goes through the remaining Parliamentary process.