Australia: Disclosure And Damages

There's no let-up in the bad news for companies that are struggling with the disclosure requirements of the ASX Listing Rules and the Corporations Act.

Fines, class actions and damages claims have all been in the headlines recently:

• the Federal Court imposed a $500,000 fine on Chemeq for non-compliance with the continuous disclosure rules;
• the High Court gave the green light to litigation funding, thus endorsing the financial underpinning for shareholder class actions based on allegations of non-disclosure by companies;
• the WA Supreme Court awarded almost $2 million damages against junior miner Jubilee, for late disclosure of price-sensitive information;

Together, these developments send a very strong message to listed companies.

In late July, the Federal Court imposed an agreed fine of $500,000 on Chemeq for non-disclosure.¹

Chemeq pleaded guilty, so the only thing for the Court to determine was the size of the penalty. Normally, these things don't yield much in the way of useful precedent, but this case is different.

The Court set out a list of factors relevant to penalty. These seem to indicate that, if you do breach the continuous disclosure rules, the Court will take account of what subsequently happened to the senior executives and directors who headed the company at the time of the breach. The Court said that, among other things, it will look at:

"8. Remedial and disciplinary steps taken after the contravention and directed to putting in place a compliance system or improving existing systems and disciplining officers responsible for the contravention.

9. The seniority of officers responsible for the non-disclosure and whether they included directors of the company.

...

11. Any change in the composition of the board or senior managers since the contravention."

In Chemeq's case, the Court specifically took note of the fact that, among other things:

"6. Responsibility for the contravention is to be located at the most senior levels of the company.

7. The composition of the Board and senior managers of Chemeq has changed substantially since the contravention."

In other words, it would appear, a company hit with a continuous disclosure allegation may need to consider dropping or disciplining those executives and directors who were in office at the time of the alleged breach.

Although not directly concerning continuous disclosure, the High Court decision in Fostif will have a direct impact in this area.²

Fostif concerned a class action by retailers against wholesalers. The class action was funded by a litigation funder. The wholesalers challenged the class action in the High Court, on two grounds. One of these grounds related to the technical procedures used by the retailers. The other ground was based on an argument that litigation funding is an abuse of court.

The wholesalers won their case, but only on the first ground. The High Court said that litigation funding is not an abuse of court.

This decision has two effects:

• it partially endorses a number of litigation-funded shareholder class actions already underway; and
• it will probably encourage more such litigation in the future.

At present, the State and Commonwealth Governments are looking at whether to regulate litigation funding.³ However, this is more likely to result in statutory guidelines to protect consumers who join a funded class action than in any significant curtailment of the litigation funding industry.

Finally, there's the Jubilee Mines case.⁴

Jubilee was a small gold explorer. In 1994 it got a letter from WMC. The letter said that WMC had accidentally done some drilling on one of Jubilee's tenements. WMC supplied the drill and assay results. These showed the presence of nickel. Jubilee effectively filed the letter away and went on looking for gold.

In 1996, WMC began talks with Jubilee about the possibility of a joint venture in relation to the nickel in the tenement. Following this meeting, Jubilee announced the 1994 drilling results to the market. Jubilee's share price went up.

Jubilee was then sued for damages by a shareholder. The shareholder had sold a large number of Jubilee shares between 1994 and 1996. He claimed that he would have held back and sold at a later time if the nickel drilling results had been announced to the market on 1994.

The Court held that the nickel results had been materially price-sensitive information back in 1994, and so should have been disclosed to the market at that time. The shareholder was awarded damages.

The Court applied a "reasonable person" test to determine whether information was materially price-sensitive: would a reasonable person expect the information to have had a material effect on the company's share price at the relevant time?

To answer this question, it was necessary to determine:

what is a reasonable person; and

what sort of investors should the Court look at when deciding whether the information was price-sensitive?

On the first of these issues, the Court said that a reasonable person in this context is not "a stockbroker or a geologist or a seasoned trader, but ... a reasonable person".

On the second issue, the Court was prepared to look at the type of company and the type of people who usually trade in its shares:

"[I]t is not relevant to ask what a member of the general public might make of the information. Nor is it relevant to consider the information from the point of view of a stockbroker or a geologist or a mining entrepreneur. What is to be considered is the perspective of the person who `commonly', as opposed to occasionally or rarely, invests in securities. There are, of course, persons who commonly invest in securities but would not dream of investing in speculative mining stocks. Presumably such persons would never be in a position of deciding whether to buy or sell such shares. They simply do not trade in that area. So the notional person to be considered in this case is a person who commonly invests in small speculative miners."

In this particular case, the Court had little hesitation in finding that investors in small speculative miners would have made investment decisions on the basis of the nickel results. In arriving at that conclusion, the Court dismissed two arguments by Jubilee.

The company argued that the nickel results would not have affected its share price in 1994 because it was then just a gold miner. The Court's response, in essence, was that a junior explorer is a junior explorer first, and a gold or nickel miner second: "there is no reason why, if, in the course of exploration activities it comes across an interesting result for nickel when it is looking for gold, it cannot then go off and look for nickel."

The company's second argument was that it would have been more circumspect if it had announced the nickel results in 1994 - any announcement would have included a statement that the company didn't intend to follow up on the nickel results. The Court rejection was blunt:

"[I]t is simply not the practice of junior explorers to include negative sentiments when announcing positive results. ... That is just not the way that junior explorers operate."

The Jubilee case is the first time that a Court has considered the continuous disclosure rules in detail. The company has reportedly said that it is going to appeal the decision. Nevertheless, the Court's comments do provide some interesting guidance for all listed companies.

What makes this case particularly important is that it was not an open-and-shut case. It didn't involve such obviously price-sensitive information as profit or loss figures, or problems with a company's key contracts. Rather, it was information that did not appear to be related to what the company saw as its core business. But that, as the Court made clear, was not the appropriate test. The test is: how would investors in our type of company react to the information? This requires the company to look at itself from the outside. In Jubilee's case, the Court said that investors would regard the company as junior explorer, rather than as a goldminer, and they would react to the nickel information accordingly.

It is difficult to know how far this principle should be taken. For example, if a company's register is dominated by institutions, should price sensitivity be determined by reference to their likely reaction (as opposed to that of retail investors)? It's also interesting to note that the Court's advice to listed companies was:

"If there is any doubt about whether the information is material, then the company ought to err on the side of caution and make the release."

When Jubilee argued that this would lead to ASX's being swamped by irrelevant information, the Court replied that that, if it ever happened, would be ASX's problem. In other words, a company shouldn't hold information back out of a tender concern for ASX.

More generally, these developments may be the forerunners of a wave of litigation-funded class actions by disgruntled shareholders. They may also produce a more aggressive stance from ASIC. Until now, ASIC has tended to rely on its infringement notice powers when enforcing continuous disclosure (the issue of an infringement notice allows the recipient company to pay a relatively small fixed sum and thereby avoid the possibility of ASIC court proceedings). However, armed with both the trophy of a $500,000 fine in the Chemeq case and the Court's strict approach to continuous disclosure in the Jubilee case, ASIC may be more willing to go hunting for scalps in the courts, rather than using the softly, softly infringement notice procedures.