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SECURITIES MARKET ACT
This paper looks briefly at the new Securities Markets Act from the point of view of small shareholders rights, and gives a rough guide to the effects on that group.
Disclosure
The new regime reinforces the existing orthodoxy – disclose the information and leave shareholders to enforce rights provided to them. Examples can be found in s.19A, where the continuous disclosure regime is outlined:
- "(1) The purpose of this subpart is to provide for appropriate continuous disclosure by public issuers of material information that is not generally available to the market.
- "(2) The following criteria are relevant to the implementation of that purpose (without limiting other relevant criteria):
- "(a) providing an appropriate level of protection for investors:
- "(b) seeking to maintain the integrity and international competitiveness of the New Zealand listed markets:”
s.19L provides an example of the private rights conferred:
"(1) The Court may make an order under subsection (2), on the application of the Commission or any other person, if it is satisfied that a public issuer has contravened a continuous disclosure obligation or a term or condition of a continuous disclosure exemption.” (emphasis added)
In general, the Act provides for an increased role of the Securities Commission, as a complete second tier to the formulation and approval of the listing rules(which is still primarily done by the NZSE), and a significantly increased involvement in monitoring the rules ,of which 19L above is an example. However, the NZSE still remains the prime first tier investigative and enforcement agency.
Insider Trading
The new insider trading regime is an example. Under s.18A the Commission can exercise the issuers rights against an inside trader. Under s.19G the Commission can order disclosure, and impose a fine of up to $30,000.00. Under s.19L it can seek the Court make a similar order for disclosure, and the fine goes up to $300,000.00. In that case, a party affected by the non-disclosure can recover any loss sustained (s.19M).
However, these rights are only available against the Issuer, not the promoter, directors or officers. This could lead to disastrous consequences – if an action is commenced, the company has to use company funds to pay any fine, and company funds to pay losses sustained by shareholders. The practical effect will be to encourage all shareholders to claim loss (otherwise their subscriptions will be used to pay out other shareholders), leading almost inevitably to the insolvency of the company.
The new Act represents a divestiture of power held by NZSE in the area of enforcement, increasing the role of the State and reducing the importance of the purely contractual arrangements between the NZSE and the listing entity. It also clearly makes the Securities Commission the “best friend” of investors (subject to the comment made about the practical effects of enforcement), who will be able to “coat tail” initiatives by the Commission, and lobby for the Commission to act.
Lack of enforcement by shareholders under old Act
The Securities Amendment Act 1988 lasted 14 years, which wasn’t a bad run. It came in just after the 1987 crash. There are 8 reported cases dealing with shareholder enforcement of insider trading prohibitions over that period, and half of those were appeals, making a grand total of 4 fact situations were shareholders took action.
Under the Securities Act 1978 itself there were provisions for shareholder enforcement. Section 55 deals with the use of an advertisement or prospectus. Section 56 provides a remedy if the advertisement or prospectus is misleading. Section 57 provides a similar result for expert’s statements. Section 61 prevents contracting out, and section 65 preserves all other available remedies.
These provisions were in place throughout the turbulent and spectacular 1980’s, which saw some very questionable corporate practices. The total of reported cases using the shareholder enforcement provisions appears to be – nil. There are a number of helpful cases saying what will be required if action is taken – but no decided cases under the relevant sections themselves are reported.
Procedural Avenues
The High Court Rules have always allowed shareholders to come together to take action against a company or a director, provided a substantive right to do so existed – see High Court Rules, R.78 (Representative actions), RR. 73, 76 (multiple Plaintiffs), R.95 (Relator proceedings – making the Attorney General enforce rights and obligations imposed usually under statute), R.81 (appointment of representation by third party – guardian ad litem). However, the incidence of the use of these procedures by shareholders appears very limited. The reported cases using these procedures do not feature shareholders as a group utilising these rights.
Another avenue for the shareholder litigant since 1993 was the derivative action, which enabled the shareholder to take over the rights of the company, and enforce them. This overcomes the old law that prevented a shareholder exercising the rights of the company, dating back to Foss v. Harbottle (1843) 2 Hare 461.
The amendment to the 1955 Companies Act, was section 209X. There was only 1 reported case under that section before it was abolished in 1997. The application was only successful in part – although the shareholder was entitled to sue in the name of the company, the prime benefit of the section, namely to use the funds of the company to do so, was not granted. However, access to the company funds was the prime advantage for shareholders.
Under the 1993 Companies Act, the relevant section is 165. Even with the benefits of access to the company resources to fund the proceeding, there only seem to be about 5 reported cases over the last 9 years. When one considers that this section applies to all registered companies, of which listed companies form a minute part, this is an extraordinarily low number of cases.
Wakefield Hospitals Ltd as an example
In August 2002 the Securities Commission released it’s report regarding Wakefield Hospitals Limited. The full text is on it’s web site at .
The terms of reference for the report seem to indicate the report was self-generated by the Commission, and was to consider any evidence that may be material to whether there was false or misleading information in the registered prospectus, whether the directors knew this was false, and whether “the directors of WHL had reasonable grounds to believe, and did believe up to the time of allotment of the securities, that the prospectus was true…”
The Commission concluded that the prospectus “was misleading because it failed to adequately describe the risks faced by WHL relating to subcontracting of publicly funded cardiac surgery”. Further, that “the directors of WHL did not undertake adequate financial due diligence to examine the risks and uncertainties concerning publicly funded cardiac surgery…”. But finally, that “in preparing the offer document, and at the time of allotment of shares, the directors of WHL held an honest but mistaken belief that subcontracting …for the provision of publicly funded cardiac surgery would re-commence….”
Being honest is not a defence under the relevant provision of the Securities Act (s.56), which simply provides:
“…the following persons shall be liable to pay compensation to all persons who subscribe for any securities on the faith of an advertisement or registered prospectus which contains any untrue statement for the loss or damage they may have sustained by reason of such untrue statement, that is to say:
(c) In the case of a registered prospectus, every person who has signed the prospectus as a director of the issuer or on whose behalf the prospectus has been so signed, or who has authorised himself [[or herself]] to be named and is named in the prospectus as a director of the issuer or has agreed to become a director either immediately or after an interval of time:
There is a defence (s.63), which is alluded to in the terms of reference – that the directors had an honest and reasonable basis for a belief that the statements were true.
The section reads:
“(1) If in any proceedings against any person for … breach of duty… in connection with—
(a) An offer to the public or allotment of securities;
[(b) The distribution of a registered prospectus or advertisement;]…—
it appears to the Court hearing the case that the person is or may be liable in respect of the .. breach of duty… but that he [or she] has acted honestly and reasonably, and that having regard to all the circumstances of the case, including those connected with his [or her] appointment, he [or she] ought fairly to be excused for the… breach of duty… the Court may relieve him [or her] either wholly or partly from his [or her] liability, on such terms as the Court may think fit.” (emphasis added).
As to that defence, look at the second finding of the Commission – no adequate due diligence. That must mean the evidential foundation for the second limb of the defence is lacking.
Consequently, the finding of an honest belief is rather like saying the directors are home if they can jump 2 meters, and finding as a fact that they can jump 1. Not very helpful to the directors. But very encouraging to shareholders who have lost money – subscribing at $2.50 per share when the market valued the shares after disclosure was made and the Commission’s report was released, at about $1.30.
The second to last paragraph of the report refers the matter to shareholders, having outlined their rights under section 37A(1)(b) (voidable allotments) and section 56 (set out above), and suggests they “consider the questions of civil liability and the question of voidable allotments. Whether any action should be taken is a matter for those shareholders to determine.”
In this case there is an active small group of shareholders who are keen to pursue their rights. In the first instance, the New Zealand Shareholder’s Association Inc. (NZSA) encouraged shareholders to deliver up to the company notices seeking refunds under the voidable allotments regime. The company has resisted this on the basis that the honestly held belief finding is a defence to that section – as it may be. That argument is explored in some detail on the NZSA website – – see the entries under Wakefield Hospital in the section headed Shareholder Advocacy. The views for and against both seem strong.
The Practicalities of shareholder action
At this point the practicalities of shareholder action take effect. About 750 individual shareholders. Many institutions, but mainly individual small holdings, often of about 2000 shares. Spread all over the country.
This means most shareholders are looking at a loss of about $1.20 per share – or about $2400.00 in absolute terms. That does not represent a big incentive for individuals to act.
The dynamics of shareholder action are more like a political campaign than private legal action. Identifying people who may be dedicated to the issue is the first step.
Then forming a steering committee from that dedicated group. Then finding out who among the shareholders generally may be interested in the proceeding. Then finding out how to structure a proposal that will meet the likely needs of those shareholders, set against the requirements of the litigation process. Then putting a proposal to the interested shareholders, working out the responses to see if the action is viable, and all this before embarking on the case itself.
Litigation itself is not simple. The Court has to sanction representative actions. That is a preliminary step. Two considerations are central to that – proof of reliance on the prospectus by each of the represented shareholders, and proof of the damage suffered by each shareholder. There is substantive law on these problem areas that needs to be carefully considered and worked through.
Then there is the issue of costs, in the event of the action failing. This is not straightforward in representative actions.
The need to brief and retain expert witnesses is a cost factor, as is the potential need to replicate everything the Securities Commission has already established in it’s enquiry.
The case management process adopted by the Department for Courts also is a problem for litigants, especially in administratively complex cases such as those involving a group of shareholders. Case management is the process whereby the Court determines how quickly a case is to come on for hearing – in other words, how quickly the parties have to spend their money.
What this example shows is the significant administrative hurdles that exist in the path of shareholder action.
The New Act
To the extent that the new Act starts to dismantle those hurdles, it is very welcome.
Sections 19 G, K, L,and M, which will allow shareholders to coat tail in relation to continuous disclosure, have been noted. Section 19P gives shareholders the status to appear in any Court proceedings under this part of the Act, where they can show they have suffered or may suffer loss.
Section 19N gives the Commission a special status in relation to the costs of any such proceedings, which should encourage it to take the lead in any such disputes. It is a clear signal that the government has taken on board the costs effects of litigation.
Disclosure remains the key plank to the entire regime. Having these new enforcement provisions in place, in relation to that key provision, is very helpful and will go a long way towards improving investor confidence. The message now needs to be taken to the investing public.
NZSA
The New Zealand Shareholders’ Association Incorporated was formed to establish an effective voice for the small shareholder. It has been remarkably effective, having established a membership in one year, that took the Australian version of the same organisation 24 years to reach – and that is in absolute numbers, not proportionate to heads of population or size of the respective markets. So there has been a clear need for it.
This new Act has given some added and much needed assistance to the process of restoring investor confidence. The involvement of the Securities Commission will allow the costs of enforcement to be minimised to investors. The Commission will not always act, of course. But given that the effective annual incidence of activity by shareholders is zero, and even in a good year statistically insignificant, anything it does will be an improvement. That is the advantage of a low base point.
The orthodoxy of disclosure has been given some effective teeth. Shareholders (through the NZSA) will be encouraging the Commission to bite.
Ultimately, it may be a new model is required, that removes the NZSE entirely from the rule making and enforcement roles, as advocated by the NZSA at . However, the new Act does appear a step in the right direction.
R M Dillon
April 2003 |
