Last week the High Court released its judgment in Du Val Capital Partners Limited v Financial Markets Authority [2022] NZHC 1529. The decision upholds the Financial Market Authority's (FMA) direction order against Du Val (a New Zealand real estate, investment and asset management group) that its promotion of an investment in the Du Val Mortgage Fund Limited Partnership (Mortgage Fund) constituted conduct that was in breach of the fair dealing provisions of the Financial Markets Conduct Act 2013 (FMCA).
The decision of the High Court is notable as it is the first appeal against an FMA direction order made under section 468 of the FMCA, and also provides useful clarification on the application of section 19 of that Act.
The Appeal
Factual Background
Between 2020 and 2021, Du Val sought funding for the acquisition and development of projects through the offer of redeemable units in the Mortgage Fund to people who certified that they were wholesale investors under Schedule 1 of the FMCA (Offer). The redeemable units entitled investors to a fixed rate of return of 10% per annum. Du Val initially promoted the Offer by publishing promotional materials on social media and web advertising.
On 4 October 2021, the FMA issued a direction order under section 468 requiring Du Val to cease and desist from publishing the promotional materials, take the promotional materials down from all marketing channels and ensure that any further promotional materials for the Offer complied with the specific guidelines set out in the direction order.
The direction order stated that the FMA considered Du Val's promotional materials for the Offer were likely to mislead or deceive potential investors in breach of section 19 of the FMCA because the materials contained representations that:
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the risk associated with the Offer was low, where in fact the risk associated with early stage financing for a property development is not; and
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there were no fees associated with the Offer, when the General Partner was entitled to 100% of the profit above the 10% fixed return to investors.
Du Val's appeal sought to have the direction order set aside on grounds that it was wrong in law.
High Court Judgment
The High Court found that the FMA's direction order contained no material errors in law and dismissed Du Val's appeal. The most significant aspects of the High Court's judgment are set out below.
Appeals against a section 468 direction order limited to questions of law
The High Court confirmed that, in an appeal against a direction order made by the FMA under section 468 of the FMCA, its jurisdiction is limited to questions of law.1 The Court's judgment was therefore confined to whether the FMA's direction order was materially wrong in law, and factual determinations made by the FMA could only be challenged as an error in law if they were clearly insupportable.
Test in Godfrey Hirst to be applied
The Court accepted that section 19(1) is analogous to section 9 of the Fair Trading Act 1986 (FTA) and, therefore, that legal precedent on section 9 of the FTA would be relevant in applying section 19 of the FMCA.
It was common ground that the correct legal test to determine whether Du Val's promotional material was likely to breach section 19 was the test set out in Godfrey Hirst NZ Ltd v Cavalier Bremworth Ltd, where the Court considered the correct application of section 9 of the FTA.2 The Godfrey Hirst test is an objective assessment, requiring consideration of the following two enquiries:3
- Firstly, to whom are the representations targeted (ie to the public at large or a specific class of persons)? This involves a factual assessment, to be determined objectively having regard to the nature of the representations and how and where they are published.
- Secondly, what is the standard of care to be expected of the potential investors? In this regard, potential investors must exercise a degree of care which is reasonable, having regard to all circumstances, including the characteristics (level of knowledge, acumen, ability etc) of the potential investors.
In assessing the second limb of the test, the High Court accepted the FMA's submission that it is incorrect to assume that all wholesale investors can be characterised as inherently more sophisticated than non-wholesale investors. The Court noted that the fair dealing provisions are designed to protect all investors and, while the FCMA indicates a general statutory intention that wholesale investors have sufficient investment acumen to not require disclosure, this generalisation is indicative, and not determinative, of the characteristics of wholesale investors. For example, an investor could meet the criteria of a wholesale investor simply due to inheritance, owning several residential properties, or having a Kiwisaver fund in excess of $1 million, rather than having particular investment expertise.
The Court accepted that, when applying the Godfrey Hirst test, both enquiries should exclude any outliers, that is, potential investors who are unusually ill equipped, or those whose reactions are extreme or fanciful. However, the Court rejected the idea that unsophisticated wholesale investors should be excluded as outliers when assessing whether representations targeted to wholesale investors are misleading or deceptive.
Publications are not saved by detailed, subsequent disclosures
The Court also endorsed the principle set out in Godfrey Hirst that a breach of section 19 cannot be cured by providing corrective disclosure in further, more detailed, materials. For example, Du Val could not rely on further information set out in its subsequent information memorandum to cure its misleading and deceptive promotional materials. That said, investors seeking to recover investment losses under the civil liability provisions of the FMCA will still need to prove their damages and establish a causative link to the issuer's conduct (ie reliance on the relevant publication materials).
Marketing channels matter
While not extensively considered by the Court, extracts of the FMA's order illustrate that the marketing channels used by Du Val (ie social media and other online channels) were an important factor which contributed to the FMA's findings. The FMA said that Du Val's "widespread promotion…particularly through social media, demonstrates that an inexperienced audience were exposed to representations made by Du Val".
Direction orders require detailed reasons
The Court rejected the FMA's submission that direction orders need not contain detailed reasons for the FMA's decision. Although it accepted that direction orders are at the lower end of the enforcement spectrum and are intended to be a flexible and efficient enforcement tool, it said that sufficient reasons for the FMA's order are required.
Key takeaways
When assessing whether promotional materials targeted at wholesale investors pass muster from a fair dealing perspective, it is the overall impression or dominant message that is of crucial importance. While it can be tempting to assume that all wholesale investors will have a level of sophistication akin to institutional investors, the High Court's judgment provides a clear message to issuers that not all wholesale investors are created equal. The characteristics of your audience should be assessed objectively in each instance having regard to the materials and conduct in question, the marketing channels used and the likely audience to be reached.
The FMA has recently also published guidance on the key principles it expects issuers to consider when advertising financial products or services.4 The guidance emphasises that whether an advertisement is likely to mislead, deceive or confuse depends on the overall impression perceived by the investor (intent is not relevant) and that investors who are vulnerable are more susceptible to being misled, deceived or confused. Advertising that is likely to mislead, deceive or confuse, whether or not it is actually misleading, deceptive or confusing, is sufficient to breach the fair dealing provisions and attract a stop order.
This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.