The High Court has cleared the former directors of Feltex Carpets Limited (Feltex) of any liability for alleged disclosure failings in the carpet-maker’s 2004 prospectus in a representative action on behalf of shareholders who purchased shares in the initial public offer (IPO) and subsequently suffered loss on that investment. The Court has also found two Credit Suisse entities, First New Zealand Capital and Forsyth Barr Limited clear of any liability relating to claims alleging misleading statements.
Feltex was a long-established New Zealand manufacturer of carpets. In 2004, the owner, Credit Suisse resolved to sell Feltex and on 5 May 2004, Feltex issued a combined investment statement and prospectus to make an IPO. Following a book-build process, the share price was set at $1.70 with the offer closing on 4 June 2004.
The primary claims alleged against the defendants were that the defendants:
- breached the provisions of the Securities Act 1978, by reason that the prospectus contained untrue statements;
- breached the Fair Trading Act 1986 in that components of the prospectus were misleading; and
- owed the shareholders a duty of care in tort and breached this duty by way of the negligent misstatements in the prospectus.
Summary of the Outcome
1. The Securities Act claim
Dobson J found that none of the plaintiff’s criticisms of the prospectus amounted to an untrue statement that could give rise to liability under the Securities Act.
A statement in a prospectus is untrue under the Securities Act when that statement is misleading in the form and context in which it is included. The plaintiff submitted that that test required the prospectus to be considered on the whole. Justice Dobson, however, agreed with the defendants that a plaintiff is required to identify the passages from the prospectus that are alleged to address a material point in misleading terms. His Honour found that the assessment as to whether a particular statement is misleading should be performed on a statement by statement basis, having regard to the surrounding context to the extent that that context is relevant to the understanding of the relevant document (for example, where that subject is addressed elsewhere in the prospectus).
When allegations relate to an omission from a prospectus, a particular statement must be identified in the prospectus that is rendered misleading by the omission of additional information which would be material to understanding that statement in the form and context in which it is included. Accordingly, a plaintiff cannot pleads omissions in an abstract sense (ie that the impression the prospectus gives is misleading because additional information ought to have been provided).
Whether a particular statement or omission is misleading will be assessed objectively. The test is the effect the statements would have on a “prudent but non-expert person” (or the “notional investor”) as the intended recipient of the prospectus. Dobson J considered the attributes of that notional investor (which have been the subject of recent judicial opinion in failed finance company cases), and, in particular, whether the notional investor would seek advice on aspects of the prospectus that he or she did not understand. His Honour held that there is a material difference between the notional investor in regards to a defined term debt investment in a finance company and an open ended equity investment in an IPO for a manufacturing company. The relevant notional investor in this case was held to be one that recognises the content of the prospectus that he or she does not understand and would therefore seek clarification on the meaning of such passages before deciding to invest.
First New Zealand Capital and Forsyth Barr Limited as JLMs of the IPO, and Credit Suisse Asian Merchant Partners as the vendor of the shares, were held to not be promoters in terms of the IPO. Under the Securities Act, a promoter is “instrumental” to the plan under which the securities are offered, and a person who is instrumental was held by the Court to be a party with a close measure of personal involvement in the process, a level of authority enabling any promoter to have, or at least share, a measure of control over decisions as to the form and terms on which the offer of securities is made.The three defendants who advanced the argument were found to be outside this primary element of construction of a promoter.
In order to make out his claim for misstatements in the Feltex prospectus, the plaintiff was required to prove that he subscribed for shares “on the faith of” the prospectus and that he suffered loss “by reason of such untrue statement”. Although he was not required to determine the issue (because none of the alleged misleading statements / omissions were made out), Dobson J held that the expression “on the faith of” contemplates a plaintiff relying on the prospectus in general in deciding to invest. Although a plaintiff doesn't necessarily need to rely on specific aspects of misleading content or omission, the untrue statement or statements must be sufficiently material that, if corrected, it would then have been more likely than not that the investment would not have been made.
Dobson J also found that, even if misleading content or omissions were made out, the plaintiff had not made out that he had suffered any recoverable loss.
2. No liability under the Fair Trading Act
Dobson J considered whether liability could lie under the Fair Trading Act where it did not arise under the Securities Act. His Honour found that the provisions of the Acts prohibit that alternative ground of liability where the claim relates to conduct that is regulated under the Securities Act and liability for that conduct has not be found under the Securities Act.
3. No liability in negligence
Justice Dobson held that where the source of an obligation is in statute and the statute prescribes a specific regulatory regime for the conduct, an additional claim in negligence has limited utility. An existing remedy is available under the Securities Act for the conduct complained of against promoters and directors and therefore a claim in negligence against the relevant defendants would not enhance that remedy in any way. Furthermore, it was held that any relationship between the JLMs and the investors in the IPO (through their reliance on the prospectus) was not one that justifies imposing a novel duty of care.
4. Due diligence defence
Even though no untrue statements were made out, Justice Dobson recorded his views on the availability of the “due diligence” defence pleaded by each defendant. The due diligence defence excuses a defendant from liability for an otherwise misleading statement if he or she had reasonable grounds to believe, and did believe, the relevant statement was true.
The due diligence process in the IPO was held to be very thorough. For example, various components of the prospectus were allocated to personnel best qualified to make those contributions, extensive legal due diligence was conducted, Ernst & Young conducted a review of the prospective financial information and provided a statutory report, and sign offs as to accuracy and reasonableness were obtained from senior managers.
Justice Dobson agreed that the responsibility of directors to be satisfied as to the accuracy of the prospectus does not require them to conduct all research personally. Rather, the relevant task is rather one of due inquiry. Additionally, while it was noted that the thoroughness of the process itself does not make out the due diligence defence, it was held that all relevant components of the process were undertaken sufficiently thoroughly, and with the application of genuine consideration.
As the Court held no statements in the prospectus were untrue it was not required to decide conclusively whether the due diligence defence was made out. However, Justice Dobson did take the view that the defendants, if required, would be likely to be able to prove they had reasonable grounds for belief in the accuracy of what was produced and therefore be able to rely on the defence.
The plaintiff has until 13 October 2014 to appeal.
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