Supreme Court hands partial victory to former Feltex shareholders
The Supreme Court has awarded a partial victory to 3,639 former Feltex shareholders in their long-running claim based upon misstatements in the company’s 2004 IPO prospectus. Feltex went into receivership in 2006, resulting in a total loss to shareholders. The claim is for approximately $185 million.
The shareholders sued the directors of Feltex who were in office at the time of the IPO. They also sued the sale promoter, Credit Suisse Private Equity Inc., the former owner and vendor, Credit Suisse First Boston Asian Merchant Partners LP, and the Joint Lead Managers of the IPO, First NZ Capital and Forsyth Barr.
The Court of Appeal had earlier found that the prospectus contained an untrue statement, which was an inaccurate revenue and dividend forecast for the period ending 30 June 2004. The Court of Appeal held that this was a breach of section 56 of the Securities Act, since replaced by the Financial Markets Conduct Act. However, the Court found that the forecast could not give rise to liability under the Securities Act because it was not sufficiently material. The Court also found that the forecast was not a breach of the Fair Trading Act.
On appeal, the Supreme Court overturned the finding that the forecast could not give rise to liability under s56 of the Securities Act. The Court held that the forecast could give rise to liability, provided it was proved that the investors acquired their shares “on the faith of” (meaning in reliance on) the prospectus and that they suffered loss as a result. The Court directed that the issues of reliance and loss would need to be decided in a High Court trial. The Court also found that the forecast was a breach of the Fair Trading Act and directed that the High Court would need to determine whether it was appropriate for a remedy to be granted.
The judgment affects only the claims against the directors and the Credit Suisse entities as promoter and vendor. The Supreme Court agreed with the decision of the Court of Appeal that the claims against the JLMs, which were not “promoters” for the purposes of the Securities Act, could not succeed.
What the decision means for financial markets participants
The Supreme Court’s decision is of interest in the following respects.
- The Court held that the requirement for reliance was satisfied if an investor relied upon a prospectus in a broad sense, including by relying upon market commentary. An investor did not need to have read the prospectus or to have relied upon the specific statements that were misleading. Furthermore, it may be inferred that, if a prospectus contained a misleading statement, investors will have invested in reliance upon the prospectus in the assumption that the statement was not misleading, unless they in fact knew the truth. This means that reliance will not be difficult for investors to prove.
- Investors must also prove that they suffered loss as a result of an untrue statement. The Court held that they will have suffered loss if the price they paid was higher than it would have been if the prospectus had not been misleading. Where an untrue statement is especially egregious and its effect obvious, investors may be able to claim the full amount they invested. Investors may have different risk appetites so outcomes may differ between them.
- The forecast was misleading because although it was only 2.8% higher than the actual full year revenue, the only forecast quarter was the final quarter (the previously quarters’ revenue was known). In that final quarter, revenue was 10% below forecast. The industry was cyclical and this compounded the significance of an unexpected fall in revenue in a quarter.
- The Court held that it was unfair for defendants to be exposed to liability under the Fair Trading Act when they had defences under the Securities Act, as this would render those defences ineffective. However, the Court did not make a finding as to whether on the particular facts of this case the Fair Trading Act should be read down so that liability was not imposed where the defendants were entitled to Securities Act defences. The Court held that a decision must await specific findings at trial.
- The JLMs were not “promoters” for the purposes of the Securities Act. While they were “instrumental” in preparing the plan to put the prospectus to the market, their role was “ministerial and advisory” in character and they were entitled to rely upon an exception for professional advisors. Nor could they be liable under the Fair Trading Act in the absence of an alleged misrepresentation by them (they did not make the revenue forecast).
The FMCA’s approach to misleading statements in offer documents is fundamentally different to that under the Securities Act, so the findings of the Court are not directly applicable, but the following principles are nevertheless relevant.
- Under the FMCA, a court may make a compensatory order where a person suffers loss “because of” a contravention. The FMCA also contains a presumption that a person who acquires financial products that decline in value after a contravention will have suffered loss as a result of the contravention. The Supreme Court’s observation that reliance will not be difficult for investors to prove therefore remains true under the FMCA.
- The test for whether a statement in an offer document is misleading is likely to be similar under the FMCA and the Securities Act. The findings of the Court with respect to the significance of the forecast for the final quarter will be relevant in future cases involving forecasts.
- A court has a broad discretion under the FMCA to award damages and make other orders to compensate investors for losses. It is likely that the courts’ approach to determining whether loss has been suffered and what order is appropriate is likely to be broadly similar to the Securities Act.
- The Fair Trading Act issues are no longer relevant, as the Securities Act was amended in 2006 to provide that a person cannot be liable under the Fair Trading Act if that person is not liable under the Securities Act. The FMCA contains misleading conduct provisions that are similar to the Fair Trading Act and provides that conduct that contravenes offer document provisions does not contravene the misleading conduct provisions, even where there is no liability because of a defence.
- The FMCA does not refer to “promoters”; third party liability now depends upon whether a person is “involved in a contravention”, which is defined in terms of aiding, abetting, counselling, procuring, inducing, being knowingly concerned in, or conspiring to effect the contravention. These elements require knowledge of a contravention. JLMs should therefore be liable under the FMCA only where they have knowledge of a contravention as well as participating in it.
The proceedings are also noteworthy because they are a “representative action” brought by a named plaintiff on behalf of many others, with the costs of the proceedings being met by a third party litigation funder. New Zealand has not, to date, experienced the large numbers of high value securities representative proceedings, many of them successful, that have been brought in Australia. The few representative actions that have been initiated in New Zealand have largely been unsuccessful.
The plaintiffs in the Feltex litigation continue to face evidential challenges, but if they are successful at trial or in achieving a settlement following the Supreme Court’s decision, this may encourage a new enthusiasm for representative actions by security holders.
The case has now been referred back to the High Court for a determination of the claims of reliance and loss.
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