Lombard - level of disclosure insufficient to avoid misleading investors
Lombard adds to recent judicial guidance on offer document disclosure obligations
When the High Court in Wellington sat in judgment on criminal charges brought against the Lombard directors, the honesty of the directors was not in question. Nor was the extent of external professional advice the directors sought in the preparation of the offer documents (including from solicitors with specialist expertise in the preparation of securities documents).
It was a finding by the Court of a material misjudgement by the directors as to the disclosure concerning one important aspect of Lombard's business as a finance company (its liquidity position) that resulted in them being found guilty of making "untrue" statements in offer documents under the Securities Act 1978.
On this issue, the Court found there was a material discrepancy between the liquidity squeeze confronting Lombard in December 2007, and the more confident comments on liquidity conveyed in the amended prospectus. Specifically there were two omissions, the combined impact of which the Court considered was sufficient to render the amended prospectus misleading:
- The omission of any statement describing the lack of reliable forecasts about the timing of loan repayments on which Lombard's liquidity depended; and
- The omission of any disclosure on the reduction and adequacy of cash resources and the directors' concerns on that topic. Although there was a general warning about liquidity risk, the Court found that it did not go far enough in terms of disclosing the real and present concerns the directors had about the company's deteriorating cash position.
The statutory defence of reasonable grounds for belief in the accuracy of the amended prospectus was not made out in relation to these material omissions as to liquidity.
So what guidance does the Lombard decision (and the other finance company prosecutions it builds on) offer directors when approving offer documents?
- Directors have a core responsibility to ensure the accuracy of offer documents and this cannot be delegated.
- In determining the appropriate level of disclosure, the focus is on the "prudent but non-expert" investor (as formulated by Heath J in the prosecution of directors of Nathans Finance Limited) and what this "notional investor" needs to be told to be adequately informed on material matters.
- There is a focus by Courts on the overall impression conveyed by offer documents, and on key issues (e.g. liquidity) - rather than a refined, line by line, analysis of statements made.
- While a director can take into account information and opinions provided by professional advisers or by management, the director must ensure that the director is comfortable, not just with the competence of the adviser generally, but with the advice and information they give from time to time.
- The fact that lawyers, auditors, a regulator or management do not raise any concerns or warning signals in relation to the level of disclosure does not, of itself, excuse the directors from liability in relation to those documents.
- Just because the level of disclosure might compare favourably to an "industry norm" does not mean it meets the legal requirements.
- The need for accurate disclosure cannot be balanced against other competing considerations, such as obligations to existing investors and parent company shareholders. If something is "material", it must be disclosed.
- If a director has doubts or cause for real and present concern (as the Lombard directors did about liquidity), the fact of that concern may be "material", and may require disclosure. This is the case even if the director considers the company will ultimately come through the issue, or if with hindsight the director's concerns are shown to be unfounded. Materiality in this sense is a relatively low threshold. If the proposed disclosure might influence any investment decision, it will almost inevitably be characterised as material.
- General warnings or risk statements may be insufficient. Statements of this nature may carry the implication that the relevant adverse circumstances or risks do not currently exist, and are not imminent.
The Court was satisfied that the Lombard directors honestly believed the documents were accurate and adequate at the time they were issued. However, this was not enough to establish that it was reasonable for them to omit certain relevant information known to them or to avoid the strict liability consequences of the current securities regime.
An appeal has been signalled from at least one of the directors. The extent to which civil claims against the directors personally are pursued may well depend on the scope of any D&O insurance funds available to aggrieved investors. Although the directors have been found guilty of criminal offences in this case, there is no finding of dishonesty or deliberate offending that you would normally expect to be automatically excluded from cover under a standard D&O policy. This situation will not arise if the proposed Financial Markets Conduct Bill is enacted in its current form, as only directors who knowingly or recklessly contravene a disclosure requirement will be exposed to criminal sanctions.