It seems that hardly a week goes by in New Zealand without company directors being in the news. On a positive note, the NZX has recently introduced its Diversity Listing Rule under which listed companies will have to disclose the gender make-up of their boards of directors and officers as part of their annual report. A wider range of people (particularly women) are being encouraged to become directors. On a less positive note, potential candidates as directors will be well aware that there has been a steady stream of successful prosecutions of directors of finance companies for failing to meet their obligations, resulting in criminal convictions and sentences including imprisonment. Every current director, and every person considering becoming a director, needs to be aware of these prosecutions and the lessons from them.
What has put the spotlight on directors?
Prior to the GFC a mezzanine level of funding existed in New Zealand through finance companies. These finance companies were widely regarded by middle class New Zealanders as a place to put their "nest eggs" and many people invested their retirement savings in them. The GFC led to the collapse of over 40 such finance companies, and the loss of many hundreds of millions of dollars in investor funds. This saw the New Zealand Securities Commission (now the Financial Markets Authority) investigate the failed finance companies and scrutinise the offers of securities made to the public by them, against the statutory requirements for these offers contained in the Securities Act 1978.
Broadly speaking, the Securities Act provides that directors can be convicted of a criminal offence, whether or not there is any intention to commit a crime and whether or not there is any dishonesty, if a material statement in an offer document is untrue. The defences available to directors against these strict liability offences are limited, but focus on the director being able to positively establish that they acted honestly and had reasonable grounds to believe the (untrue) statement in the offer documents. Although this legislation has existed in New Zealand for many years, until recently there have been few cases considering the obligations of directors when signing off on offer documents for raising funds from the public.
That all changed with the onset of the GFC. There has now been a raft of prosecutions by the Financial Markets Authority against directors of the failed finance companies for alleged breaches of the Securities Act when making offers of securities to the public. This has seen criminal prosecutions of approximately 20 directors some of whom have included former Cabinet Ministers of the Crown and respected high profile business people. To date, all have been found wanting by the Courts, to a greater or lesser extent, and all the prosecutions have seen criminal convictions against the prosecuted directors, either as a result of guilty verdicts or guilty pleas. Sentences have ranged from community service and reparations, at the lower end of the scale, to home detention and imprisonment for six to seven years, at the higher end of the scale.
Lessons for directors
Key principles have emerged from the cases both in terms of general responsibilities of directors and specific responsibilities when making offers of securities to the public. The cases should give every director, or any person considering becoming a director in the future, pause for thought. It is critical that directors are aware of what is expected of them when carrying out their duties, and the consequences that could follow if they fail in these duties. While the principles that have emerged from the finance company cases are not novel, they should help re-focus directors on what is expected of them. Generally, directors must:
- Understand the business of the company they direct. They must understand the fundamentals of the business, monitor performance and review financial statements regularly. Even a non-executive director is expected to have the ability to read and understand financial statements and to use that understanding when making decisions about matters such as insolvency and liquidity.
- Have competence beyond their core area of expertise. Directors must be suitably qualified to be on the board and must have at least a basic knowledge of conventional accounting practice and concepts and should up skill if necessary.
- Ensure appropriate reporting to them.
- Exercise independent judgement when relying on management.
While the Courts will recognise that directors direct and managers manage, that does not relieve directors of their obligation to exercise independent judgement and test the competence of management within areas in which management are relied on.
- Obtain and use expert advice appropriately. This includes legal advice. Directors cannot rely solely on legal advice to fulfil their duties. Directors must pro-actively ask questions and test advice given to meet their obligations.
- Fully understand documents they are signing. The directors cannot delegate this to management or advisers and must form their own opinions on the compliance of documents they are signing. Directors should ensure there is sufficient time for discussion at board meetings so that they fully understand the matters presented to them.
Specifically, when making offers of securities to the public, directors must:
- Consider the overall impression relayed by the offer document, to ensure that no "untrue statements" are included. An untrue statement can include an affirmative statement or a material omission and whether a document contains an untrue statement will be assessed against the overall context of the offer document and the impression it conveys to investors. Directors will not be able to rely on the literal accuracy of statements in an offer document.
- Consider who will read the offer document, from the perspective of a notional investor, who will be a prudent but non-expert person.
- Not withhold material information even if to disclose it would be "non-commercial". The interests of existing investors, and whether disclosure would discourage investment, cannot be taken into account when deciding whether to disclose information in an offer document.
- Be aware that their obligations are on-going throughout the period the offer document is before the public.
A law change is proposed to the Securities Act which would modify the offence provisions and require intentional breach or recklessness on the part of directors for criminal liability to arise. However, it is clear from the finance company cases that the Courts will hold directors to a high standard when assessing their conduct and, no matter what direction the legislation takes, it is timely for all directors to take heed of the principles emerging from the cases and think carefully about their obligations. For those thinking of becoming directors, and those already at the Board table, the recent cases are a timely reminder about the responsibilities they will assume.
This article was first published in the December 2012 issue of Australasian Legal Business.