Shareholder class actions are seeing a surge this spring in New Zealand. As such, the English High Court’s first shareholder class action decision is a timely addition to the New Zealand debate – in light of the recent Myer continuous disclosure decision from the Australian Federal Court.
The UK decision shows the difficulties faced by shareholders in establishing a claim regarding directors’ recommendations to vote in favour of an acquisition.
We compare and contrast the guidance for the directors of listed companies, as well as the prospects for similar shareholder action in New Zealand.
Lloyds Banking Group (Lloyds) / HBOS – Background
At the height of the global financial crisis in September 2008, HBOS was in trouble. The UK Government then offered to assist Lloyds with an acquisition of HBOS in the interests of stabilising the banking market. It was a unique opportunity for Lloyds to acquire a major competitor.
To allow the acquisition to happen, Lloyds’ shareholders had to approve it at an Extraordinary General Meeting (EGM). In advance of that meeting, Lloyds distributed a shareholder circular (the Circular) explaining the risks and benefits of the proposed acquisition, as well as the Lloyds directors’ recommendation to shareholders to approve the purchase.
Within months of the acquisition, it became apparent that the financial crisis and HBOS’s financial position was worse than expected. Lloyds’ shares plummeted and never bounced back to their pre-acquisition level.
Lloyds shareholders’ claims
The shareholders claimed that:
- the directors’ recommendation to approve the acquisition was negligent because the directors’ due diligence was insufficient; the recommendation failed to account properly for funding and capital risks involved; and the directors exaggerated the risks of Lloyds’ future viability without the transaction, and
- the directors failed to provide shareholders with sufficient information about the risks of the transaction, and the Circular contained negligent misstatements or failed to properly disclose that:
- the Bank of England was providing unique emergency liquidity assistance (ELA) to HBOS at the time
- Lloyds had provided a £10b loan facility to HBOS as a temporary liquidity measure during the acquisition process, and
- Lloyds had internally estimated impairments on HBOS’s assets greater than market consensus.
The shareholders said that, due to these ‘failures’, the acquisition would not have happened as either the directors would have abandoned the acquisition or the shareholders would have voted against it.
The Court reached an orthodox conclusion on the scope of directors’ obligations regarding recommendations to shareholders.
The Court held that a reasonably competent chairman or executive director in the circumstances could have held the view that the acquisition was beneficial to Lloyds’ shareholders. While reasonably competent directors may reach different conclusions, to establish negligence a claimant must show that no reasonably competent director could have made the recommendation. Courts are to guard against hindsight analysis, especially in circumstances where events have turned sour.
Directors don’t have to assume the worst possible outcome will occur and can instead take a “fair and balanced view on…the realities, based on probabilities”. In reaching their decision, directors can rely on independent professional advice (such as from investment bankers) unless there is a manifest error in that advice or its underlying factual assumptions.
Appropriate disclosure to shareholders
On non-disclosure, the Court considered both the directors’ equitable duty to provide shareholders with sufficient information and the obligations of the law of negligent misstatement.
Sufficient information duty
In considering the Circular, the Court found that the document must give a fair, candid and reasonable account of the relevant circumstances. The document is assessed objectively, and need not disclose:
- all material that was available to directors
- everything that a shareholder may take into account, and
- information that the directors would have discovered if they had initiated further reviews or enquiries.
To be fair to the shareholders voting, the document must include a consideration of the weaknesses of the transaction, but does not need to emphasise or overstate them.
The Court acknowledged that, in the creation of such a document, there will inevitably be a selection process to determine what information is included.
The negligent misstatement analysis was also orthodox: did the directors follow an appropriate process and have appropriate advice on whether the information should be disclosed?
Conclusion on disclosure
Ultimately, the Court held that the directors were in breach of the sufficient information duty because they should have disclosed the existence of the ELA and the £10b loan. The information was likely to be relevant to shareholders as it showed where HBOS was on the road to recovery. While a breach of the sufficient information duty will not automatically prove negligent misstatement, here the directors did not take reasonable steps to satisfy themselves that it was appropriate to withhold that information, and did not seek legal advice on this point. Therefore, the representations relating to the ELA and £10b loan were negligent misstatements.
Comments on commercial practice
In reviewing the information that should have been disclosed, the Court applied a healthy scepticism when considering isolated contemporaneous dissenting opinions. The Court also stressed it is important not to take matters out of context with the benefit of hindsight. A lone dissenting voice is not evidence that the directors acted unreasonably.
The Court gave a clear caution against shareholders conducting a “trawl” through publications to identify potentially misleading statements in isolation. Instead, the full context of what was disclosed, read, and relied on must be considered.
Reliance, causation and loss
The shareholders failed in establishing that they read and relied on the alleged misstatements. 80% of the claimants acknowledged they had not read the Circular and instead sought to prove “indirect reliance”. The claimants said they read and relied on market commentary and financial journalism based on the Circular.
This approach was highly unattractive to the Court and was said to present “real difficulties”, in particular in determining the extent to which that commentary had been appropriately based on the Circular.
The shareholders struggled to establish that adequate disclosure would have produced a different outcome. At the time, only 4% of shareholders voted against the acquisition, and there was no evidence that a further 46% of shareholders would have changed their mind. Evidence from large institutional investors was lacking. Only nine of the 5800 claimants (representing 0.37% of the shares) gave evidence saying they would have voted differently if they had known about the ELA and £10b loan.
Similarly, the claimants’ ex post facto survey evidence of financial journalists did not convince the Court that adequate disclosure would have set off alarm bells through the financial press.
When considering how adequate disclosure would have been made by Lloyds, the Court accepted that any disclosure would have been “carefully framed” and would not have had the “disproportionate emphasis” placed on the issue by the shareholders.
Even if the shareholders had made out their claims, the Court would not have awarded any damages. A loss claim on the basis of:
- overpayment for HBOS shares was not recoverable by individual shareholders, but by the company, and
- diminution in value of Lloyds’ shares involved significant complexity. The shareholders’ expert suggested three approaches to calculating loss. None were accepted by the Court either on the basis of methodology or lack of supporting evidence. In particular, the Court found no claimant actually proved loss because they had not adduced evidence of what Lloyds shares they held at the time of breach.
Guidance for New Zealand
The Lloyds/HBOS judgment demonstrates the steps that a UK investor must overcome to establish negligent misstatement or a breach of the equitable duty to provide sufficient information to investors.
By contrast, New Zealand investors can rely on the fair dealing provisions of the Financial Markets Conduct Act (FMCA) which generally prohibit misleading representations and conduct, as well as the specific provisions in relation to product disclosure statements or continuous disclosure obligations.
The fair dealing regime does not require shareholders to establish a misleading representation was negligent. All that is required is the statement or disclosure was misleading, whether positively or by omission. However, shareholders still need to establish reliance on the statement and causation of loss.
As yet, there is no general concept of “indirect reliance” or “fraud on the market” in New Zealand, which assumes that a misleading representation or conduct is relied on and reflected in the market price of a financial product.
Only in the context of product disclosure statements can a shareholder rely on New Zealand’s statutory presumption that the representation or conduct has caused loss. In that situation, a shareholder need only show that they bought shares which have subsequently lost value. The onus then shifts to the defendants to establish that the loss in share price was caused by a reason other than the misleading representation or conduct.
Despite the differences in statutory regimes, the Lloyds / HBOS decision provides useful guidance on the matters which a Court is likely to consider when determining whether:
- directors have made adequate disclosure to shareholders regarding a potential transaction
- shareholders can establish that general misleading conduct has caused them loss, and
- directors can establish a defence to a continuous disclosure breach because they took reasonable and proper steps to prevent such a breach occurring.