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The Financial Markets Conduct Bill - The Cavalry to the rescue

26 April 2012

This article first appeared in the April issue of Boardroom magazine.

The Lombard convictions have cast the Financial Markets Conduct Bill into the unlikely role of the cavalry coming Hollywood-style over the hill to rescue the besieged director.

The FMC Bill is now with the Commerce Committee and is scheduled for report back to the House on 7 September.  It will retain criminal sanctions – but only where the Court is satisfied beyond reasonable doubt that the misconduct has been deliberate and reckless. 

Where there has been no intent to mislead, liability will be restricted to civil penalties and orders of compensation.  (Although these may be substantial, including compensation orders, pecuniary penalties and banning orders.)

The Bill also creates a ‘due diligence’ defence in regard to compensatory orders under which it will be sufficient to prove that the board had proper procedures and checks in place to guard against non-compliance.  Similar provisions already exist in the New Zealand Insurance (Prudential Supervision) Act and Australian statute - and the Australian Courts have ruled that the fact that a control system fails is not damning of itself as “even the best systems may break down due to human error”.

Whether the Bill would have saved the Lombard directors from a criminal conviction is, of course, a matter for conjecture.  But they would have had to be in with a chance as it was never in contention that they were “other than honest” or that they were not diligent about reading their board papers and about seeking expert advice where appropriate.

However this was irrelevant as under a strict liability test the Court did not have to establish:
  • any form of intention to mislead
  • the competence of otherwise of the directors in the performance of their duties, or
  • whether investors relied on the misinformation in making their decision to invest in Lombard Finance.

The only test, and this will remain the case until the FMC Bill is enacted, is whether the market was misled.  And the only defences available to the directors were:

  • that they had reasonable grounds to believe and did believe that all of the information provided to the market was correct, and
  • that any omissions were immaterial.

They argued reasonable belief, pointing out that none of the external professional advisers on which they relied had raised the red flag.  But the Court found that was not enough.

Justice Dobson said that, although this defence would have been “adversely” affected had the Lombard board been advised by an expert adviser to make a content change to the offer documentation, the converse did not apply: “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 positive finding that there were reasonable grounds for the directors’ belief in the accuracy of the offer documents”.

Then, echoing Justice Heath in the Nathans judgment of July 2011, he said: “The directors’ obligations in relation to the accuracy of content of offer documents are non-delegable”.

The Judge also rejected defence arguments that Justice Heath had set the bar too high in relation to the circumstances under which board members can rely on information provided by management.  Justice Heath ruled that “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”.

The Lombard defence argued that this interpretation was unreasonably narrow and that 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 said this approach would put “permissible reliance too highly”.

In Lombard, the Court also addressed an issue often faced by boards – what to do when disclosure will compromise or even destroy the company’s chances of averting financial crisis or will penalise existing shareholders by slicing value off the share price.

But the Court made it clear that the disclosure threshold is inalterable and cannot be adjusted to balance other interests: “The statutory defence of reasonable belief in the truth of content is not a variable standard of reasonableness, depending on other pressures acknowledged by directors in forming the views that they do”. 

The Lombard decision is the latest in a series of decisions in Australia and New Zealand over the last two years which have explored the scope of directors’ duties.  Specific take-outs from the Lombard case are:

  • if you think you will “squeeze through” and don’t want to alarm the market by disclosing risks which you think may not come to pass or information which may prove unduly pessimistic, that may well put you in breach of your legal obligation to disclose all material matters (anything which might influence an investor’s decision)
  • just because the lawyers, the auditors, the trustee and the Financial Markets Authority have not raised flags does not mean you are protected.  Directors’ obligations to read and form an informed view on the offering document are “non-delegable”, and
  • if you have doubts (as the Lombard directors did about the company’s liquidity position), you have to drill into them.

John Holland is a partner in Chapman Tripp’s Christchurch office, specialising in corporate and commercial law.

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