The Securities Commission proceedings against Nuplex Industries Limited and its directors is an important test case of the 2008 law changes extending liability for continuous disclosure breaches to secondary parties who were involved in contravention of the law.
The continuous disclosure obligations under the Securities Markets Act 1988 and the NZSX Listing Rules require listed issuers to release material information to the NZX once it becomes aware of it, subject to various exceptions including confidential incomplete proposals or negotiations.
The Commission alleges that Nuplex failed to disclose a banking covenant breach to the NZX in a timely manner and that the non-disclosure allowed a false market to develop in Nuplex listed shares, causing loss to acquirers of those shares at that time and material damage to the integrity or reputation of New Zealand’s securities markets.
Nuplex argues it was in ongoing confidential discussions with its banking syndicate to relax or reset the relevant covenant, and so was not required to make immediate disclosure.
Of particular interest is the Commission’s decision to also extend the action to current and former directors of Nuplex, drawing on changes made to the Securities Markets Act with effect from February 2008. Similar secondary liability also applies under the Act to breaches of the insider trading and market manipulation prohibitions, and substantial shareholder disclosure rules, and certain breaches of the Commerce Act 1986 and the Takeovers Act 1993.
Any person who aids, abets, counsels or procures, induces, conspires in, or is “in any way knowingly concerned in, or a party to”, the contravention of the law by another person (i.e. Nuplex) also contravenes the law. Although the Commission has focused on Nuplex directors, in theory company executives, legal advisers, or PR consultants involved in preparing continuous disclosure announcements, or assessing whether or not they are required, could bear extended liability.
The Commission is seeking declarations of contravention, pecuniary penalties (maximum $1 million per defendant) and compensation orders, alleging that if the covenant breach had been disclosed earlier Nuplex shares would have traded up to 30 per cent lower. ‘Declaration of contravention’ orders, also available under the Act since February 2008, allow investors that suffered loss in the relevant period (i.e. acquirers of shares in the period before the covenant breach disclosure) to secure compensation through the courts more cost effectively, because liability has already been established.
‘Due diligence’ defence
The Act contains a defence where a Nuplex director can show on the balance of probabilities that:
he or she took all steps (if any) that were reasonable in the circumstances to ensure that Nuplex complied with the disclosure obligation, and
after doing so, believed on reasonable grounds that Nuplex was complying with the disclosure obligation.
Evidence of reasonable reliance on management representations, other directors, indications from the banking syndicate that covenant relief should be forthcoming, and legal advice, should assist in making this defence.
This is the first time the Commission has brought court proceedings alleging breaches of continuous disclosure.
The Commission has made critical findings in investigations into continuous disclosure compliance by Feltex and Plus SMS Holdings but both those matters pre-dated the extended secondary liability regime, and the Commission decided not to take court action because any penalty finding would have been to the cost of shareholders.
The Nuplex case will, however, be a difficult one to win for the Commission because it necessarily involves the Court assessing the business judgment of Nuplex, and its directors, in relying on the ‘incomplete proposal’ exception over a volatile period, and extended negotiations with its banking syndicate. Australian case law in similar contexts indicates the Court will take a cautious approach substituting its judgment on commercial considerations, with the benefit of hindsight.
Conversely, Nuplex may face more exposure with the alternative false market allegation, as the ‘incomplete proposal’ exception is not available where the market appears to be materially influenced by false or misleading information.
Announcing an earnings downgrade in November 2008, Nuplex had concluded with a positive statement that it was in compliance with its financial covenants. But the Commission alleges that it failed to mention the covenant breach in a further earnings downgrade in February 2009, or to correct analyst and financial media reports that continued to convey that Nuplex remained in covenant compliance.
Nuplex’s share price fell 25 per cent a fortnight after the February earnings downgrade, as some analysts started to speculate Nuplex may no longer be in covenant compliance, provoking a NZX price enquiry which finally prompted Nuplex into making market disclosure of the banking covenant problems.
In addition to Nuplex denying liability, no doubt individual directors will seek to rely on the due diligence defence. If some directors had a greater degree of participation in the decision making process than others, the Court may find they should have done more. So it is possible that the Court could find Nuplex in breach, but some or all of the directors not!
Whatever the outcome, the action will be closely watched by listed company directors, executives and advisers.
Well advised companies have an established continuous disclosure policy to help ensure compliance with the rules, or at least formulate a basis for a defence. The Listed Companies Association, Inc executive has developed a sample continuous disclosure policy as a starting point.