Had the Financial Markets Conduct Bill been in force, criminal proceedings may not have been issued against the Lombard directors and – even if charges were laid – the outcome would probably have been very different.
This is because the Bill reserves criminal sanctions for misconduct which is deliberate and reckless – and the Judge acknowledged that it was not any part of the Crown’s case that the Lombard directors had been “other than honest”.
However, the decision contains some useful reminders for directors which should continue to be relevant when the Bill becomes law.
The legal test
The offences were ones of strict liability. The single issue for the Court to determine was whether:
- an amended prospectus issued on 24 December 2007
- three investment statements dated 28 December 2007, and
- a DVD distributed in March-April to a small number of prospective investors contained inaccuracies or omitted material information.
The Court did not have to establish:
- any form of intent to mislead on the part of the directors
- the competence or otherwise of the directors in the performance of their duties, or
- whether investors relied on the misinformation in making their decision to invest.
The defences available to the directors were:
- that any omissions were immaterial, and
- that they had “reasonable grounds to believe” and did believe that all of the information provided to the market was correct.
The Lombard directors argued reasonable belief, pointing out that none of the external professional advisers on which they relied had raised the red flag. But the Judge did not accept this defence, saying:
Certainly in the negative sense, had the accused proceeded to issue the offer documents whilst a professional adviser questioned the need for different or additional content, then that would adversely affect the reasonableness of their belief in the accuracy of the offer documents. I am not satisfied that the same relevance can be attributed in the positive sense to the absence of warning signals from competent external advisers, as supporting a finding that there were reasonable grounds for the directors’ belief in the accuracy of the offer documents. The directors’ obligations in relation to the accuracy of offer documents are non-delegable.
Findings in brief
The Judge found that the offer documentation – the prospectus and the investment statements – was misleading in relation to the seriousness and the imminence of the liquidity squeeze confronting Lombard Finance and Investments Ltd (Lombard).
He made this finding despite being satisfied on the balance of probabilities that each of the accused considered that the statements addressing the company’s liquidity were true at the time they were issued.
As it was a criminal proceeding, the Court had to be satisfied on each of the charges “beyond reasonable doubt”.
The Judge was not satisfied that this test had been met in regard to the Crown’s claims that the documents misrepresented the company’s major loans exposure and adherence to lending and credit approval policies or that they understated the deterioration in the company’s financial position since the release of the last audited financial statements.
The Court accepted a “complete absence of fault” on the part of the directors in terms of the DVD. Key to this finding was that the directors did not think the DVD would be released as they considered that they had instructed management not to use it.
Lombard v Nathans - the facts
The obvious point of comparison in determining where this judgment takes the jurisprudence on the issue of directors’ duties is the Nathans
decision of July 2011. Both proceedings were criminal, both involved finance companies and both concerned breaches of disclosure requirements.
There are important differences between the two cases also. Lombard’s loan portfolio was much more conventional than was Nathans’. The great bulk of Nathans’ lending was to its parent company, VTL, whereas Lombard was not engaged in any related party lending and its major risk was spread across five external borrowers.
Also, the Lombard’s board was not asleep at the wheel. The evidence to the Court was that the directors were diligent about reading board papers and sought and relied upon expert advice, including from solicitors with specialist expertise in the preparation of securities offers.
But, as noted above, the task before the Court was to determine whether the documents the board had signed off on were misleading, regardless of whether or not the directors had intended to mislead. As a result, any differences in the severity of the offending will be reflected in the sentencing.
Two of the Nathans directors got jail time and a third home detention in addition to financial penalties. A fourth director got home detention after a guilty plea before trial.
Justice Dobson has been clear that the charges proven against the Lombard Four are “a material step away from the seriousness required for a custodial sentence” and that he will be looking at community based sentences (and a financial penalty) at the sentencing hearing on 29 March.
Lombards v Nathans – the judgments
Because of the similarities between the two cases, Justice Heath’s judgment in the Nathans case loomed large in the Lombard proceedings and was referenced by the Judge and by lawyers for the prosecution and for the defence.
Counsel for two of the defendants argued that Justice Heath had set the bar too high in two respects.
The first related to his interpretation of the degree to which directors can rely on the advice of others.
Justice Heath ruled:
Subject to adequate monitoring of management by the directors or anything that may put a director on notice of the need for further inquiry, reliance on information provided by management in their delegated areas of authority will generally be appropriate. But every reliance inquiry will be fact specific, taking into account both the obligations and responsibilities of particular directors and the nature of the tasks delegated to members of the management team. [Emphasis added.]
The defence argued that this approach was unreasonably narrow and would require directors to undertake detailed analyses more appropriately left to management. Instead directors should be able to rely on the judgement of managers until they were put on notice that something of substance had gone wrong.
But Justice Dobson rejected this argument, saying it put “permissible reliance too highly”.
The second related to Justice Heath’s expectation that offer documents should be exhaustive in relation to disclosure, disclosing “everything of relevance that is likely to be material to the investment decision”. Justice Dobson supported Justice Heath’s view, saying he did not regard it as excessive.
He did depart from Justice Heath in one respect. The Securities Act 1978 assumes for the purposes of disclosure that the target audience is the prudent but non-expert investor. Justice Heath presumed that such investors would seek expert financial advice and, although not financially literate, would have sufficient ability to comprehend that advice.
But Justice Dobson said he “would not confine the characteristics of the notional investor to those who would be guided in their consideration of investment statements by advice from investment advisers” as it could not be assumed that everyone would seek advice.
Chapman Tripp comments
There is a measure of tragedy in having two former Ministers of Justice convicted of a crime. It would be a pity if this incident were to eclipse Sir Douglas Graham’s contribution to advancing the resolution of Treaty of Waitangi issues.
The fact that there is legislation in the pipeline which would likely have delivered a different outcome underlines the directors’ misfortune. In our view, this case vindicates the decision in the FMC Bill to reserve criminalisation for egregious and deliberate offending, while maintaining appropriate accountability and financial penalties for lesser offences.
This is the latest in a series of judgments over the last two years which have underlined the risks associated with being a director. Good people may be discouraged from taking up directorships and boards may become too risk averse to pursue growth opportunities if the spectre of criminal conviction for honest acts remained.
Which is not to suggest that directors should not be held accountable for their decisions nor that there are some important take-outs from the Lombard case. These take-outs will continue to apply under the FMC Bill, as even though the risk of criminal sanctions will be lower, the prospect of civil liability will remain.
- If you have doubts (as they did about liquidity) you do need to drill into them.
- If you have received a series of projections or reports which have proven to be overly optimistic, do not rely on further projections from this source (at least not without subjecting them to some serious scrutiny so that you are satisfied that this time it is different).
- Just because the lawyers, auditors, trustee and FMA have not raised flags does not mean you are okay. The Courts have more than once underlined that directors’ duties are non-delegable.
- Balancing the interests of new investors with those of current investors is not what is required. If something is material, it must be disclosed whether or not disclosure may have an adverse effect on the value of existing securities.
- If you think you will “squeeze through” and don’t want to alarm the market because it may not be necessary and may prove pessimistic, that is not telling investors all material information – and the law requires disclosure of all material matters (anything that might influence an investor’s decision).
- Just because a disclosure document appears to be “market standard” does not mean that it satisfies the legal requirements.