R v Moses HC Auckland CRI 2009-004-1388
[2011] NZHC 646
•8 July 2011
IN THE HIGH COURT OF NEW ZEALAND AUCKLAND REGISTRY
CRI 2009-004-1388
THE QUEEN
v
KENNETH ROGER MOSES MERVYN IAN DOOLAN DONALD MENZIES YOUNG
Hearing: 21, 22, 23, 24, 25, 28, 29, 30, 31 March 2011
1, 4, 5, 6, 7, 8, 11, 12, 13, 14, 15, 18, 19, 20, 28, 29 April 2011
2, 3, 4, 5, 6, 9, 10, 11, 12, 13, 17, 18, 19, 20, 23, 24, 25, 26, 27, 30, 31
May 2011
1, 2, 3, 9, 13, 14, 15 and 16 June 2011
8 July 2011
Counsel: C R Carruthers QC, B H Dickey, N R Williams (except 25 May to 2
June 2011) and J Blythe for Crown
P J Davison QC, S J Mount (21 March 2011 only), D C S Morris (until 11 May 2011), A C Cook (from 11 May 2011) and M A Corlett (from 13 April 2011) for Mr Moses
N S Gedye, S E Cameron and K Murphy for Mr Doolan
D P H Jones QC and D C S Morris (until 11 May 2011) and A C Cook
(from 11 May 2011) for Mr Young
Judgment: 8 July 2011
Reasons: 8 July 2011
REASONS FOR VERDICT OF HEATH J
Solicitors:
Crown Solicitor, PO Box 2213, Auckland
Cook Morris Quinn, PO Box 1295, Shortland Street, Auckland Lee Salmon Long, PO Box 2026, Shortland Street, Auckland Counsel:
C R Carruthers QC, PO Box 305, Wellington
N S Gedye, PO Box 2097, Shortland Street, AucklandD P H Jones QC, PO Box 1750, Shortland Street, Auckland
R V MOSES HC AK CRI 2009-004-1388 [8 July 2011]
Contents
1. The accused, the charges and my verdicts [1] 2. General background [7] 3. The indictment and its particulars [14] 4. The Crown case in outline [23] 5. The defence cases in outline (a) No untrue statements [26] (b) Immateriality and reasonable belief of truth [28] 6. Securities Act 1978: the statutory scheme [31] 7. Elements and onus of proof on a s 58 Securities Act charge [39] 8. The impact of the “investment statement” regime [52] 9. The characteristics of the “prudent but non-expert” person [64] 10. The regulatory regime: roles and functions (a) Introductory comments [71] (b) Directors and management [74] (c) The auditors [88] (d) The trustee [92] (e) Registrar of Companies [97] (f) External advisers [99] 11. Nathans‟ business operations (a) The VTL group structure [101] (b) Nathans’ directors [110] (c) The senior management team [127] (d) Nathans’ credit management [144] 12. Nathans‟ lending concentration (a) Classifications [150] (b) The inter-company debts [154] (c) The VTL business-related and commercial debts [157] (d) “Commercial” loans [162] 13. Preparation of the 2006 investment statement and prospectus [163] 14. The content of the investment statement and prospectus (a) The investment statement [186] (b) The prospectus [198] 15. What impression would the prudent but non-expert investor get? [207] 16. The allegations of untrue statements: the investment statement and prospectus [210] 17. Were the statements in the investment statement and prospectus materially misleading? [214] 18. The extension certificate (a) Alleged misleading statements [228] (b) Analysis [237]
19. The letters to investors (a) Letter of 14 May 2007 (i) Alleged misleading statements [242] (ii) Analysis [245] (b) Letter of 12 July 2007 [252] (c) Letter of 6 August 2007 (i) Alleged misleading statements [261] (ii) Analysis [264] 20. Reasonable grounds for belief in truth of statements: Context (a) Introductory comments [267] (b) VTL’s business – an overview (i) Interests in the United States of America [269] (ii) The Australian business [299] (c) Strategic planning (i) Nathans [315] (ii) VTL [332] (d) Information available to Nathans’ directors (i) Nathans’ board papers [364] (ii) VTL board papers [373] (e) Valuations [375] 21. Reasonable grounds for belief in truth of statements: Analysis (a) Honest beliefs [393] (b) The differing responsibilities of the directors [395] (c) The directors’ grounds for believing misleading statements were true [405] (d) Were the beliefs based on reasonable grounds? (i) Overview [407] (ii) As at 13 December 2006: prospectus and investment statement [412] (iii) As at 29 March 2007 [438] (iv) As at 14 May 2007 [451] (v) As at 6 August 2007 [454] 22. Conclusion [460]
1. The accused, the charges and my verdicts
[1] At material times, Mr Roger Moses, Mr Mervyn Doolan and Mr Donald Young were directors of Nathans Finance NZ Ltd (Nathans). Each has been charged with six counts, under s 58 of the Securities Act 1978 (the Act).1 The charges arise out of the distribution of offer documents,2 allegedly containing untrue statements,
through which Nathans offered debt securities to the public:3
(a) Count 1: Between 13 December 2006 and 30 August 2007, distributing an investment statement dated 13 December 2006 containing an untrue statement.
(b)Count 2: Between 13 December 2006 and 30 March 2007, distributing Prospectus No 8 dated 13 December 2006 containing an untrue statement.
(c) Count 3: Between 29 March 2007 and 30 August 2007, distributing Prospectus No 8 (pursuant to an extension certificate) containing an untrue statement.
(d)Count 4: On 14 May 2007, distributing an advertisement (a letter to investors dated 14 May 2007) containing an untrue statement.
(e) Count 5: On 12 July 2007, distributing an advertisement (a letter to investors dated 12 July 2007) containing an untrue statement.
(f) Count 6: On 6 August 2007, distributing an advertisement (a letter to investors dated 6 August 2007) containing an untrue statement.
1 Set out in full at para [23] below. The Securities Act 1978 has been amended a number of times since the events in issue. The provisions to which I refer are those in force at the relevant time.
2 I use the term ―offer documents‖ when referring, in a compendious way, to two or more of the
prospectus (including the extension certificate), investment statement and advertisements.
3 The indictment and the particulars provided to support it are considered in Part 3 of these reasons.
[2] Each accused pleaded not guilty to all charges and elected trial without a jury. The trial was conducted before me over 54 sitting days, from 21 March to 16 June
2011.
[3] A fourth director, Mr Hotchin, was charged in respect of the three distributions that occurred between 13 December 2006 and 15 April 2007; the latter being the date on which his resignation as a director of Nathans took effect. On 25
February 2011, Mr Hotchin entered guilty pleas to counts 1, 2 and 3. On 4 March
2011, he was sentenced by Lang J.4 Mr Hotchin was called by the Crown to give evidence against his fellow directors.
[4] Earlier today I found Mr Moses, Mr Doolan and Mr Young guilty on counts
1, 2, 3, 4 and 6. Convictions were entered on each of those charges. The three accused were found not guilty on count 5 and discharged.
[5] These are my reasons for returning those verdicts. While it is unusual for full reasons to be given in Judge-alone trials,5 it is appropriate in a case such as this. The prosecution is of public interest. Nathans was one of a number of finance companies that collapsed in 2006 and 2007. Public investors lost significant sums of money. This is the first case of its type to come before this Court. Others are to follow. Both the accused and the public are entitled to understand fully the reasons for my verdicts.6
[6] I thank counsel for their considerable assistance. I intend no disrespect to them in not setting out or reviewing their comprehensive closing arguments in detail. I have carefully considered the relevant evidence and closing addresses. I have
elected to deal only with those matters that are essential to my decisions. I
4 R v Hotchin HC Auckland CRI 2009-092-20927, 4 March 2011, Lang J. I record, in accordance with advice given to counsel prior to the trial beginning, that I have not read Lang J‘s sentencing notes. I refrained from doing so because Messrs Moses, Doolan and Young dispute aspects of the
summary of facts agreed between the Crown and Mr Hotchin, on the basis of which he was sentenced. I agreed with counsel for the accused that it was appropriate to embark on my task as a fact-finder in this trial without reference to those agreed facts.
5 See, generally, R v Connell [1985] 2 NZLR 233 (CA) at 237; R v Eide (Note) [2005] 2 NZLR 504 (CA) and Wenzel v R [2010] NZCA 501 at paras [39] and [40].
6 See R v Eide (Note) [2005] 2 NZLR 504 (CA) at para [21], in the context of reasons for verdicts in fraud cases. In my view, a similar approach is required in a case such as this, though I emphasise that no allegation of dishonest conduct is made against the accused.
acknowledge that any summary of the voluminous evidence that I have heard and read will necessarily be both selective in its content and incomplete in nature. I also accept that time constraints have resulted in these reasons being far longer than is desirable.
2. General background
[7] Nathans was a wholly owned subsidiary of VTL Group Ltd (VTL).7 VTL and Nathans were incorporated on 23 December 1997 and 23 July 2001, respectively. In 2004, after the sale of 7.5 million shares to the public at $1.00 per share, pursuant to a registered prospectus, VTL was listed on the New Zealand Stock Exchange. After the float, interests associated with Messrs Doolan and Hotchin each owned 33.2% of the company, while those associated with Mr Gary Stevens (a director of VTL) and Mr Moses each owned 4.1%.8 The public shareholding in VTL amounted to 25.4% of its share capital.
[8] Nathans carried on business as a finance company. It solicited funds from the public, through the issue of secured debenture stock. That method of raising capital is regulated by the Act. Offers to invest in ―debt securities‖ were made through the use of prospectuses, investment statements and advertisements. Pursuant to a deed of trust dated 15 November 2001, Perpetual Trust Ltd (Perpetual) was appointed as trustee for the secured debenture holders. On 20 August 2007, Perpetual placed Nathans in receivership, on the basis of its insolvency. There is a deficiency as to secured debenture holders of something in the order of $174 million.
[9] Nathans was established for the purpose of providing working capital to VTL. First tier financiers (such as trading banks) do not ordinarily lend to such a company. VTL had no trading history. Its primary asset was intellectual property. It possessed few tangible assets against which security could be taken. Its business
involved the acquisition of vending machines (depreciating assets) and the
7 VTL was previously called Vending Technologies Ltd. Its name was changed to VTL Group Ltd on
12 March 2004.
8 The shares were owned, respectively, by Mrs Doolan (as trustee of the McConnochie Trust), Mrs Hotchin (as trustee of the Boston Trust), Mr and Mrs Moses (as trustees of the Nadia Investment Trust) and Gary Stevens, Shirley Stevens and Charles Carlton (as trustees of the Milford Way Trust).
installation of a unique proprietary software into them. To maximise returns from the software product, VTL intended to establish a network of franchised machine operators to lease the machines from subsidiary companies.
[10] All of Nathans‘ directors were, at one time or another, members of the VTL
board:
(a) Messrs Doolan and Hotchin were directors of both VTL and Nathans from their respective incorporations. Mr Hotchin resigned as a director of Nathans on 31 March 2007, effective from 15 April 2007.
(b)Mr Moses joined the Nathans‘ board on 11 August 2003 and that of VTL on 4 May 2004. Mr Moses became the chairman of the Nathans board around September 2005, after Mr Hotchin resigned from that position.
(c) Mr Young was appointed as a director of Nathans on 12 September
2005 and of VTL on 13 December 2006.
Both Mr Hotchin and Mr Doolan lived overseas during parts of 2004 and 2005. Initially, they were based in the United Kingdom. Subsequently, Mr Hotchin moved to Boston to manage VTL‘s interests in the United States. Mr Doolan returned to New Zealand in July 2005.
[11] Mr Stevens was the only director of VTL who was not also a member of the Nathans board. Nevertheless, he attended a number of Nathans‘ board meetings and appears to have taken an active role in its affairs; particularly, in relation to strategic considerations. Although Mr Stevens did not give evidence, the contemporary documents indicate that his shadowy figure was lurking in the background when many significant decisions affecting Nathans‘ business interests were made, particularly in late 2006 and throughout 2007. Instructively, Mr Hotchin described Mr Stevens both as his ―boss‖ and as a ―shadow director‖ of Nathans.
[12] Although its name replicated those of finance companies previously associated with L D Nathan & Co Ltd9 (a well-known name in Auckland business circles), Nathans was not connected to that group. I am satisfied that the name was chosen (before either Mr Moses or Mr Young became involved) to lend a degree of respectability to a new entrant into the finance market.
[13] The charges arise out of a series of events from the issue of a prospectus and
investment statement in December 2006 through to Nathans‘ receivership, in August
2007. The prospectus and an investment statement were lodged with the Registrar of Companies on 13 December 2006. An extension certificate10 was signed by two directors of Nathans (Messrs Doolan and Hotchin) and dated 29 March 2007. Registration of that document (on 30 March 2007) enabled Nathans to continue to solicit funds under the December 2006 prospectus. On 14 May, 12 July and 6
August 2007, letters were forwarded to investors. The Crown alleges that those letters constitute ―advertisements‖ as defined in the Act.11 There is a dispute about whether the July letter falls within that definition.
3. The indictment and its particulars
[14] Following their committal, the Crown filed an indictment against the three accused and Mr Hotchin. After Mr Hotchin‘s pleas of guilty were entered, an amended indictment was filed. That formed the basis on which the trial proceeded.
[15] On 24 May 2010, the accused requested further particulars of the indictment. Following correspondence, the Crown responded formally to the request on 20
December 2010. As a matter of law, the trial proceeds on the basis that the indictment contains those further particulars.12
[16] The Crown made it clear that while it had ―referred to a number of untrue
statements in the particulars‖, it also relied on the offer documents and
9 Nathans Finance No 1 Ltd and Nathans Finance Ltd.
10 Securities Act 1978, s 37A(1A).
11 Ibid, s 2A.12 Crimes Act 1961, s 334(2).
advertisements ―read as a whole and the overall impression conveyed by them‖.13
Reliance was placed on the whole of the offer documents in order to provide a context within which to assess whether misleading statements had been made.14
[17] Mr Gedye for Mr Doolan (supported by counsel for both Mr Moses and Mr Young) emphasised a fundamental tenet of fair trial principles: an accused has the right to know in detail the nature and cause of any charges that he or she may face, in order to meet them. Mr Gedye submitted that the Court ought not to go beyond specific statements identified by the Crown in the particulars of each count to find that an untrue statement was made. He submitted that it was impermissible for the Crown arbitrarily ―to seek to find a home for pure omissions by pointing to some oblique or distant or contrived relevance to an existing statement‖. Mr Gedye used the term ―pure omission‖ to refer to something that was not material to an existing statement in a prospectus or advertisement.
[18] To support those submissions, Mr Gedye referred to the Securities Commission‘s Report of an Enquiry into a Registered Prospectus issued by Agricola Resources Limited dated 3 June 198615 and relied on the wording of s 55(a)(ii) of the Act, a provision that, on his submission, ―requires a direct and close and natural connection between the omitted matter and the statement relied on‖.16
[19] Section 55 of the Act is designed to provide a wider meaning to the word
―untrue‖ than its popular use. For present purposes, the focus is on whether a
relevant offer document is ―misleading‖. Section 55 states:
55Interpretation of provisions relating to advertisements, prospectuses, and registered prospectuses
For the purposes of this Act,—
(a) A statement included in an advertisement or registered prospectus is deemed to be untrue if—
13 Citing Aaron’s Reefs Ltd v Twiss [1896] AC 273 (HL) at 281; Arnison v Smith (1889) LR 41 Ch D
348 (CA) at 369 and R v Rada Corp Ltd (No 2) [1990] 3 NZLR 453 (HC) at 474.
14 Securities Act 1978, s 55(a).
15 Securities Commission Report of an Enquiry into a Registered Prospectus issued by Agricola
Resources Limited dated 3 June 1986 (1991) [Agricola Resources report].
16 See also paras [43] and [44] below.
(i) It is misleading in the form and context in which it is included; or
(ii) It is misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is included:
(b) A statement is deemed to be included in an advertisement or registered prospectus if it is—
(i) Contained in the advertisement or registered prospectus; or
(ii) Appears on the face of the advertisement or registered prospectus; or
(iii) Contained in any financial statements, report, memorandum, or document that accompany, or are incorporated by reference or referred to in, or distributed with, the advertisement or registered prospectus:
(c) A certificate registered under section 37A(1A) of this Act, and any financial statements that accompany that certificate, shall be deemed to be included in the registered prospectus to which the certificate relates.
[20] When pressed, Mr Gedye accepted that some form of logical linkage between an omission and a particular statement might be appropriate, but he emphasised the element of proximity. While I accept the thrust of Mr Gedye‘s submission based on the purpose of particulars, a narrow approach to relevant contextual evidence is unwarranted. Section 55(a)(ii) recognises that ―suppression of the truth suggests the false‖.17 A half truth can be as much misleading as a lie. If the absence of something material could lead an investor not to take account of factors relevant to an investment decision, s 55(a)(ii) will apply. The authorities make the obvious
point that it is the overall impression conveyed by the offer document that is important, not a painstaking analysis of individual sentences contained in it.18
[21] It is true, as Somers J said in R v Arnold (No 1),19 that the ―object of particulars is to enable [an accused] to know fairly what he has to meet‖. However,
there is no prejudice to an accused unless he or she were taken by surprise in
17 John Farrar and Mark Russell Company Law and Securities Regulation in New Zealand
(Butterworths, Wellington, 1985) at 365, adopted in the Agricola Resources report, at para 9.8.
18 See Peek v Gurney (1872) LR 6 HL 377 (HL) at 386; Arnison v Smith (1889) LR 41 Ch D 348 (CA) at 369 per Lord Halsbury LC; Aaron’s Reefs Ltd v Twiss [1896] AC 273 (HL) at 281; R v Kylsant [1932] 1 KB 422 (CA) at 448-449; R v Rada Corporation Ltd [1990] 3 NZLR 438 (HC) at
446-447 and R v Rada Corporation Ltd (No 2) [1990] 3 NZLR 453 (HC) at 474.
19 R v Arnold (No 1) [1977] 1 NZLR 718 (SC) at 721.
answering the charges. In the course of a trial spanning some three months, there was no suggestion, at any stage, that the accused were surprised by the way in which the Crown put its case or that some other form of prejudice had resulted. While it is necessary for the Crown to be kept within the limits of its particulars, a relatively broad view of the contextual evidence is appropriate when considering the specific allegations of untrue statements.
[22] That approach is consistent with the way in which the Court deals with applications to amend an indictment during a trial. If there were debate about the terms of a particular count, it is always open for the Crown to seek leave to amend, to conform to proof.20 There is no reason why any different approach should be taken in respect of particulars. The critical issue is whether the accused have been taken by surprise or have been prejudiced in the way in which the defence was (or
could have been) conducted. In this case, they have not.
4. The Crown case in outline
[23] A director of a company that distributes a prospectus or an advertisement (including an investment statement) that contains an untrue statement commits a criminal offence, punishable on conviction on indictment by a maximum term of imprisonment of five years or a fine of $300,000.21 Section 58 of the Act provides:
58 Criminal liability for misstatement in advertisement or registered prospectus
(1) Subject to subsection (2) of this section, where an advertisement that includes any untrue statement is distributed,—
(a) the issuer of the securities referred to in the advertisement, if an individual; or
(b) if the issuer of the securities is a body, every director thereof at the time the advertisement is distributed—
commits an offence.
(2) No person shall be convicted of an offence under subsection (1) of this section if the person proves either that the statement was immaterial or that
20 Crimes Act 1961, s 335(1) and (2).
21 If the offence were a continuing one a further fine of $10,000 per day may be imposed in respect of every day that the offence continues.
he or she had reasonable grounds to believe, and did, up to the time of the distribution of the advertisement, believe that the statement was true.
(3) Subject to subsection (4) of this section, where a registered prospectus that includes an untrue statement is distributed, every person who signed the prospectus, or on whose behalf the registered prospectus was signed for the purposes of section 41(b) of this Act, commits an offence.
(4) No person shall be convicted of an offence under subsection (3) of this section if the person proves either that the statement was immaterial or that he or she had reasonable grounds to believe, and did, up to the time of the distribution of the prospectus, believe that the statement was true.
(5) Every person who commits an offence against this section is liable—
(a) on conviction on indictment to—
(i) imprisonment for a term not exceeding 5 years; or
(ii) a fine not exceeding $300,000 and, if the offence is a continuing one, to a further fine not exceeding
$10,000 for every day or part of a day during which
the offence is continued; or
(b) on summary conviction to—
(i) imprisonment for a term not exceeding 3 months; or
(ii) a fine not exceeding $300,000 and, if the offence is a continuing one, to a further fine not exceeding
$10,000 for every day or part of a day during which the offence is continued.
It is common ground that each of the offer documents was ―distributed‖ on or about
the dates alleged in the specific counts, for the purposes of s 58(1) and (3).22
[24] The Crown‘s specific allegations that the offer documents contained ―untrue‖
statements may, conveniently, be distilled and classified under eight headings:23
22 When the hearing ended on 16 June 2011, an appeal from Venning J‘s judgment in R v Petricevic HC Auckland CRI 2008-004-29179, 25 March 2011 had been heard by the Court of Appeal but judgment remained reserved. That case considers the meaning of ―distribution‖ in the context of a charge which alleges that an offer document became misleading after it was originally distributed; the question being whether the concept of ―distribution‖ is a continuing one. That point does not arise in this trial. The issue was left on the basis that if any of the accused were convicted and the Crown wished to raise the issue of a continuing offence as an aggravating factor on sentencing, it would be open for the accused to request a disputed fact hearing: Sentencing Act 2002, s 24. The Court of Appeal‘s judgment was delivered on 5 July 2011: R v Steigrad [2011] NZCA 304. I have
endeavoured to incorporate any relevant observations.
23 A summary confined to five headings under which the particulars are grouped is set out at para
[213] below.
(a) Misleading statements that advances to VTL and its subsidiaries (the inter-company advances) had been made on a ―commercial arm‘s length basis‖, normally for terms no longer than 12 months;
(b)Omitting to disclose an expectation that each of the inter-company advances would be rolled-over on due date, with all interest being capitalised;
(c) Omitting to disclose the true extent of VTL business-related indebtedness;24
(d) A misleading statement that the liquidity of Nathans was supported by
VTL;
(e) Omitting to disclose a significant deterioration in the liquidity profile of the company between the financial statements for the year ended 30
June 2006 and the date of distribution of the prospectus, investment statement, extension certificate and advertisements respectively;
(f) A misleading statement that Nathans had no bad debts;
(g)Misleading statements about the standard of corporate governance, credit assessment and credit management processes that operated within Nathans; and
(h)Misleading statements relating to the growth of a commercial lending book and diversification of lending undertaken by Nathans.
[25] The Crown‘s fundamental complaint is that the directors allowed the various
offer documents to go into the market containing materially misleading information
about core aspects of Nathans‘ business and its actual financial position.
24 This is a term I have adopted. I define it at para [151](b) below.
5. The defence cases in outline
(a) No untrue statements
[26] Mr Moses, Mr Doolan and Mr Young each contend that the statements were not misleading. Their position is that a notional reader of the prospectus, investment statement and advertisements would have gained a proper understanding of the position of the company and the relevant investment risks from the text of the various offer documents and the audited financial statements contained in the prospectus.
[27] The accused place greater emphasis on the literal accuracy of statements made in the prospectus, including the figures contained in the financial statements. In contrast, the Crown approach was more focussed on the impression likely to be gained by a recipient of the relevant offer document.
(b) Immateriality and reasonable belief of truth
[28] If, contrary to their contention, I were to find that one or more of the statements in the offer documents was untrue, each director says that any misleading statement was immaterial or that he had, at the relevant time, an actual belief based on reasonable grounds that the statements were true.25
[29] I agree with counsel for the accused that the reasonableness of any such belief should be assessed from the perspective of each individual director, based on the information available to him at the relevant time. I eschew a ―hindsight‖ based evaluation that would likely be over-critical of a director‘s actions. Deliberately, I take a (contemporary) ―boardroom‖, rather than a (financial autopsy) ―courtroom‖,
approach.
25 Securities Act 1978, s 58(2) and (4). Resolving a prior debate on this issue, the Court of Appeal has confirmed that s 58(2) and (4) should be treated as affirmative defences: R v Steigrad [2011] NZCA
304 at para [44].
[30] Reliance on other persons is a significant aspect of each director‘s belief that the statements were true. On occasions the directors relied on each other; for example, when one reported to the board on a particular issue for which he had primary responsibility. More generically, the directors say that they relied on information conveyed to them by:
(a) Members of Nathans‘ senior management team (including in-house counsel) who had the responsibility to undertake specific tasks in relation to the offer documents.
(b) Nathans‘ auditors, Staples Rodway. They provided two unqualified
audit opinions; one on the financial statements for the year ended 30
June 2006 and the other for the purposes of the prospectus.
(c) Perpetual and the Registrar of Companies, on their examination of the prospectus and investment statement.
(d) External advisers, such as lawyers, accountants and valuers.
6. Securities Act 1978: the statutory scheme
[31] It is unlawful to make an offer of securities to the public unless it is made in (or accompanied by) an investment statement, an authorised advertisement that is not an investment statement, or in (or accompanied by) a registered prospectus.26 In
2006 and 2007, the form of a prospectus and an investment statement had to comply with both the Act and the Securities Regulations 1983 (the Regulations).27
[32] An investment statement must state that there is a registered prospectus containing an offer of securities to which it relates28 and bring to the attention of
26 Ibid, s 33(1).
27 Ibid, s 33(1)(a) and (c). The regulations in force between November 2006 and August 2007 were
the Securities Regulations 1983. The Securities Regulations 2009 came into force on 1 October 2009.
28 Ibid, s 38E(1)(c).
potential investors that other important information is available about the securities.29
[33] Nathans was subject to that regulatory regime because it offered debt securities to the public. A ―debt security‖ is one in which the investor has the right to be repaid its money.30 No debt security may be offered to the public for subscription unless a trustee has been appointed and the trust deed has been registered with the Registrar of Companies.31 Perpetual was appointed as trustee under a trust deed dated 15 November 2001.
[34] A prospectus has a lifespan of nine months from the date of the last audited financial statements. In this case, the last audited accounts were for the year ended
30 June 2006, so the period of nine months expired on 31 March 2007. That period can be lengthened if an extension certificate were signed on behalf of all directors.32
In that certificate, all directors of the issuer, having made due enquiry, must state that, in their opinion:33
(a) The financial position shown in the statement of financial position referred to in paragraph (b) of this subsection has not materially and adversely changed during the period from the date of that statement of financial position to the date of the certificate; and
(b)The registered prospectus is not, at the date of the certificate, false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances.
Such a certificate is deemed to be part of the registered prospectus to which it relates.34
29 Ibid, s 38D(1)(b).
30 Ibid, s 2(1), definition of ―debt security‖.
31 Ibid, s 33(2).
32 Ibid, s 37A(1A).
33 Ibid, s 37A(1A)(c)(i) and (ii).34 Ibid, s 55(c).
[35] An offer of securities to members of the public has never been treated as akin to offers to acquire other commodities. As long ago as 1877, Lord Coleridge CJ in Twycross v Grant35 explained why, in a passage that is as true today as it was 134 years ago:
All purchasers equally run the risk of buying a comparatively worthless article, and of being misled by untrue representations as to its nature and value; and from risks of this kind no special legislation was necessary to protect shareholders. The value of a share in a company, however, depends not only on those circumstances which regulate the value of all saleable commodities, but also on persons by whom and the mode in which the capital of the company is to be dealt with. It is utterly immaterial to an ordinary purchaser to know what the vendor will do with the purchase money when he gets it: the purchaser has no further interest in it. But an applicant for shares in a company is in a totally different position. This money becomes part of the capital of the company; and to him it is all important to know what sort of persons are to have the control of his money where has paid it, and how that money is to be applied, whether upon the enterprise itself or in remunerating, perhaps with lavish extravagance, those who have brought the company to its existence. (my emphasis)
[36] The purpose of the Act is the protection of investors: Re AIC Merchant Finance Ltd.36 Richardson J described the ―pattern of the Securities Act and the sanctions it imposes‖ as designed ―to facilitate the raising of capital by securing the timely disclosure of relevant information to prospective subscribers for securities‖. The underlying policy is simple. Full disclosure enables a potential investor to make an informed decision whether to invest. Equally, a potential investor cannot make an informed choice without all information that is both relevant and material to the decision:37
It is perhaps true to say that the premise underlying the Securities Act, as with much commercial law, is that the best protection of the public lies in full disclosure of the company's affairs and of the security it is offering. That then allows the investor to make an informed investment decision, which in turn facilitates the functioning of financial markets.
[37] The content of a prospectus and an investment statement is prescribed by the
Regulations. In the context of an offer of debt securities:38
35 Twycross v Grant (1877) 2 CPD 469 at 483. See, more generally, Andrew Borrowdale and others
Morison’s Securities Law (looseleaf ed, LexisNexis) at para [1.6].
36 Re AIC Merchant Finance Ltd [1990] 2 NZLR 385 (CA) at 391-392 per Richardson J. Neither
Casey J nor Doogue J disagreed with Richardson J‘s analysis.
37 Ibid, at 392. See also DFC Financial Services Ltd v Abel [1991] 2 NZLR 619 (HC) at 629 per
Fisher J and R v Steigrad [2011] NZCA 304 at paras [75] and [76].
38 Securities Regulations 1983, regs 3(2) and 7A.
(a) Every registered prospectus relating to an offer of debt securities must contain all of the information, statements, certificates and other matters specified in Schedule 2.
(b)While the minimum information to be contained in an investment statement is set out in Schedule 3D to the regulations there is no limitation on the information that may be contained in that type of document.39
[38] Section 58 of the Act is one of the criminal sanctions imposed to encourage compliance with the statutory regime. Directors also face the prospect of civil liability.40 Both civil and criminal sanctions are directed to a situation in which false material statements are made in a prospectus or an advertisement.
7. Elements and onus of proof on a s 58 Securities Act charge
[39] The charges in relation to the prospectus and extension certificate are brought under s 58(3);41 those in relation to the investment statement and letters to investors invoke s 58(1).42 The offences are ones of strict liability. The Crown is not required to prove any criminal intent on the part of the directors. While an honest director can be guilty of an offence, no person can be convicted if he or she were to prove either that the statement was immaterial or that he or she had reasonable grounds to
believe and did, up to the time of the distribution of the offer document, believe that the statement was true.43
[40] A strict liability offence is justified by the nature of an offer of securities to members of the public. The public rely on those responsible for making the offer to disclose everything of relevance that is likely to be material to the investment decision. Investors do not have insider knowledge. The need for a serious sanction
for non-disclosure arises out of the prospect of loss being suffered by innocent
39 Securities Act 1978, s 38E(3); Securities Regulations 1983, reg 7A(5).
40 Securities Act 1978, s 56.
41 Counts 2 and 3: see para [1] above.
42 Counts 1, 4, 5 and 6: see para [1] above.43 Securities Act 1978, s 58(2) and (4).
investors through reliance on misleading statements, whether made deliberately or innocently.
[41] Section 58(1) and (3) require the Crown to prove that a statement is ―untrue‖. There are two types of statements that will be deemed ―untrue‖. The first applies to an affirmative statement, contained in the relevant offer document. Section 55(a)(i) deems a statement to be ―untrue‖ if it were misleading in the ―form and context in which it is included‖.44 The other is an omission. The ―omission of a particular which is material to the statement in the form and context in which it is included‖ is also deemed to be ―untrue‖.45
[42] Two points should be made about the inquiry into whether a statement is misleading. The first is that the question must be judged contextually, not literally. Second, even if there may be some truth in what is said, a statement that fails to divulge the whole truth may also be false and, therefore, misleading.46
[43] The question whether the offer document contains an affirmative statement that is ―untrue‖ is viewed through the eyes of a notional investor.47 The inquiry is objective in nature. The onus of proving that a misleading statement has been made rests on the Crown. That must be proved beyond reasonable doubt. If the Crown were to prove a misleading statement to that standard, the onus shifts to the directors to demonstrate, on a balance of probabilities, that it was immaterial or that he or she had reasonable grounds to believe that the statement was true.48
[44] When the Crown seeks to rely on an omission, the position is slightly different. As part of its obligation to prove beyond reasonable doubt that the statement is misleading, the Crown must also prove (to the same standard) that the statement is misleading by reason of an omission which is material to the statement. It is then a discrete question whether an accused can establish, on a balance of
probabilities, that a statement that is deemed to be misleading is, nevertheless,
44 Ibid, s 55(a)(i).
45 Ibid, s 55(a)(ii).
46 See the authorities collected in n 17 and 18 above.
47 R v Rada Corporation Ltd (No 2) [1990] 3 NZLR 453 (HC) at 465.48 Care must be taken to consider the questions of ―immateriality‖ and ―reasonable grounds‖
discretely, as they raise different issues. See Department of Justice v Witehira (1996) 7 NZCLC
261,184 (DC) as an illustration of a problematic approach, in that regard.
immaterial to any investment decision. Therefore, the defences available under s 58(2) and (4) are equally available in circumstances where s 55(a)(ii) is invoked.
[45] Questions of materiality or immateriality are opposite sides of the same coin. Using the term ―immaterial‖ as his starting point, Mr Gedye submitted, citing District Registrar of Companies v Heenan,49 that the term should be interpreted as
―of no essential consequence; unimportant‖. In Heenan, Judge Callaghan had referred to the definition of ―immaterial‖ in the Oxford English Dictionary, having previously considered a discussion of the term ―materiality‖ in Coleman v Myers50
and TSC Industries Inc v Northway Inc.51 Mr Gedye urged caution in a case where
the question of materiality was not ―exceedingly clear‖.
[46] Mr Carruthers QC, for the Crown, relied on Coleman v Myers and a very recent decision of the Supreme Court of the United States, in Matrixx Initiatives, Inc v Siracusano.52 Judgment in that case was delivered on 22 March 2011, the day after this trial began. Matrixx involved a case of alleged securities‘ fraud under § 10(b) of the Securities Exchange Act of 1934 (US) and Rule 10b-5 of the Securities and Exchange Commission Rules. The rule made it unlawful to ―make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made ... not misleading‖.
[47] In Matrixx, the appellant had urged the Supreme Court to depart from the test of ―materiality‖ adopted and applied by that Court in both TSC Industries53 and Basic, Inc v Levinson.54 The Court declined to do so, endorsing its earlier approach. Sotomayor J, delivering the judgment of a unanimous Court, said:55
... assessing the materiality of adverse event reports is a ―fact-specific‖ inquiry ... that requires consideration of the source, content, and context of the reports. …
Application of Basic’s ―total mix‖ standard does not mean that pharmaceutical manufacturers must disclose all reports of adverse events.
49 District Registrar of Companies v Heenan (1997) 8 NZCLC 261,334 (DC) at 261,349.
50 Coleman v Myers [1977] 2 NZLR 225 (CA).
51 TSC Industries Inc v Northway Inc 426 US 438 (1976).
52 Matrixx Initiatives, Inc v Siracusano 563 US
(2011) (slip opinion) at 9-10.
53 TSC Industries, at 449 and Basic Inc v Levinson 485 US 224 (1988) at 231-232.
54 Basic Inc, at 226.
55 Matrixx Initiatives, applying Basic at 232.
.... The question remains whether a reasonable investor would have viewed the nondisclosed-information ―as having significantly altered the ―total mix‖ of information made available‖. (original emphasis)
[48] That test that has been consistently applied in the United States and is the basis for the test of materiality adopted by the Court of Appeal in Coleman v Myers, Cooke J having relied on TSC Industries, where it was first expressed. While using different wording, it also accords with other authorities that are helpfully summarised in an article by Peter Fitzsimons, ―‗Materiality‖ and the Securities Act
1978‖.56 Mr Fitzsimons discussed the development of the law relating to
―materiality‖, in the context of the Act. It appears that when the Davey Committee reported to the Parliament of the United Kingdom in 1895, it emphasised the importance of disclosure by indicating that a prospectus should disclose everything which could reasonably influence the mind of an investor of average prudence.57
That expression of the concept takes on particular significance in New Zealand,
given the adoption of the ―prudent but non-expert‖ investor as the person to whom
an investment statement is directed.58
[49] Our Court of Appeal in R v Baxter59 referred to a ―piece of information ... which the recipients of the prospectus certainly needed in order properly to be able to assess the risk of the investment. Cooke J, in Coleman v Myers,60 spoke of something between a situation in which a potential investor ―might‖ or ―would‖ be influenced by omitted information. He also referred to ―considerations which can reasonably be said, in the particular case, to be likely materially to affect the mind of a vendor or a purchaser‖, in the context of an agreement to sell shares in a company.61
[50] Examples of the use of different phrases to capture the same concept can be found in one of the older cases, Broome v Speak.62 At first instance, Buckley J spoke
56 Peter Fitzsimons ―‗Materiality‘ and the Securities Act 1978‖ (2000) Companies and Securities Law Bulletin 18. See also Fitzsimons‘ helpful summary of the provisions in the Securities Act and Regulations that focus on questions of ―materiality‖.
57 Davey Committee Report of the Companies Acts (Amendment) Committee (C 7779, 1895) at para 6.
58 Securities Act 1978, s 38D(a). See also paras [52]-[70] below.
59 R v Baxter [1998] 3 NZLR 144 (CA) at 157.
60 Coleman v Myers, at 334 per Cooke J, with whom neither Woodhouse J nor Casey J differed on this point.
61 Ibid, at 334, relying on the test expressed by Marshall J in TSC Industries, at 449.
62 Broome v Speak [1903] 1 Ch 586 (Ch and CA).
of withheld information that, if disclosed, would reasonably ―deter or tend to deter an ordinary prudent investor from applying for the shares‖.63 In the Court of Appeal, Collins MR, while approving Buckley J‘s formulation, expressed the view that an intended investor was entitled ―to have every element for enabling him to form a judgment, as to whether he will or will not subscribe for shares, fairly put before him ...‖.64 Cozens-Hardy LJ wrote of ―a contract ... of such a nature that the intending investor may reasonably require to consider it before determining whether he shall or shall not apply for shares in the company‖.65
[51] Respectfully, in company with Cooke J, I do not consider it is appropriate to attempt to define the concept of ―materiality‖ too tightly. The various phrases found in the Davey Committee report and the cases to which I have referred are all based on a common theme. At the risk of adding a further phrase to the debate, if there were something that ought to have been disclosed that could well have made a difference to the decision whether to invest, it would almost inevitably be characterised as ―material‖.
8. The impact of the “investment statement” regime
[52] Existing authorities on s 58 prosecutions are concerned only with prospectuses and advertisements. The events described in those cases pre-date the Securities Amendment Act 1996, by which the investment statement regime was introduced. The nature and purpose of that regime impacts on the characteristics of the investor from whose perspective a determination must be made about whether a statement in an offer document was misleading and, if so, material to an investment decision.
[53] The investment statement regime was introduced in response to a report by the Task Force on Private Provision for Retirement (the Todd report).66 The proposal
to introduce a more informal disclosure document was adopted in the Accord on
63 Ibid, at 604.
64 Ibid, at 621 and 622.
65 Ibid, at 629.66 Jeff Todd ―Private Provision for Retirement: The Way Forward‖ (Task Force on Private Provision for Retirement, December 1992) [the Todd report].
Retirement Income Policies (the Accord) entered into by the National, Labour and
Alliance political parties in August 1993:67
4.1 Disclosure about savings products
Having considered the recommendations of the Task Force, the Parties agree that in respect of unit trusts, superannuation schemes, life insurance, and other financial investment products offered to the public (referred to as
―savings products‖ in this Accord), legislation should be enacted to provide
that –
(a) certain statutory minimum disclosure requirements should apply in respect of all savings products (both when the initial commitments are made and on an annual basis thereafter);
(b) the disclosure requirements should require the cost-effective disclosure of information which meets the reasonable needs of the prudent but non-expert investor;
(c) the disclosure requirements should facilitate comparisons between savings products.
[54] Those sentiments were repeated in subsequent recommendations of the Working Group on Improved Product and Investment Adviser Disclosure (the Working Group)68 and the select committee report that considered the Investment Product and Adviser (Disclosure) Bill 1995, by which the proposed investment statement regime was introduced into Parliament.69
[55] Those responsible for the reforms labelled the notional investor as a ―prudent but non-expert‖ person. Reflecting the terms of the Accord, the Working Group identified four ―key principles‖ for the development of minimum requirements:70
(a) A disclosure policy, to provide such investors with sufficient information to enable them to make their own informed decisions;
(b)Coverage of all public offerings, so that the disclosure requirements extend to all investment products offered to the public;
67 An Accord on Retirement Income Policies (August 1993), cl 4.1.
68 The Working Group was established in December 1993 to develop recommendations for the implementation of Part 4 of the Accord.
69 Investment Product and Adviser (Disclosure) Bill 1995 (138-2) (select committee report).
70 Ibid, at ii; see also (22 August 1996) 557 NZPD 14255.
(c) The need for neutral and equivalent rules to avoid regulatory distortions arising from different disclosure requirements that lack a coherent rationale; and
(d) The need for the new rules to be cost effective.
[56] The Todd report considered that information in a prospectus was not
―consistently provided in an understandable or reliable form by existing providers of financial advice‖.71 In the context of a particular focus on the type of information that would assist people to make decisions about and to save for their retirement, the Todd report referred to ―the information [that] savers need to make quality decisions about the products that best suit their needs and preferences‖. That came to be the foundation for the investment statement.
[57] As an adjunct to its primary recommendation, the Todd report also recommended the introduction of legislation to address questions of disclosure from those who held themselves out as providing investment advice. Those recommendations were implemented by the Investment Adviser (Disclosure) Act
1996, in which definitions of both ―investment advice‖ and ―investment adviser‖
appear.72
[58] The Act confirms that the adequacy of information disclosed in an investment statement must be evaluated from the perspective of a ―prudent but non-expert person‖. Section 38D provides:
38D Purpose of investment statement
The purpose of an investment statement is to—
(a) Provide certain key information that is likely to assist a prudent but non-expert person to decide whether or not to subscribe for securities; and
(b) Bring to the attention of such a person the fact that other important information about the securities is available to that person in other documents.
71 The Todd Report, at 71.
72 See paras [68] and [69] below. This was the legislation in force in 2006 and 2007. With effect from 29 February 2008, the Investment Advisers (Disclosure) Act 1996 was repealed, by the Securities Markets Amendment Act 2006.
The need for ―key information‖ to be disclosed is reinforced by reg 7A(1) of the Regulations. That provision refers to information that must be set out in an investment statement ―in a succinct manner‖.
[59] While s 38D of the Act is clear about the intended audience of an investment statement and the perspective from which its content should be viewed, should the same approach be taken to a prospectus?
[60] Unlike an investment statement, the prospectus contains the last audited set of financial statements. In order to ensure that a prospective investor has access to all relevant information about the offer, the investment statement must advise that further information is available in the prospectus.73 To that extent there is an intended linkage between the investment statement and the prospectus.
[61] Mr Gedye referred me to a number of authorities that have considered the perspective from which the content of a prospectus should be viewed. All of those authorities dealt with factual situations that arose before the investment statement regime came into force.
[62] In R v Baxter,74 the Court of Appeal referred only to the ―recipients of the prospectus‖. No consideration was given to the level of knowledge or financial literacy of such people. In R v Rada Corporation Ltd (No 2),75 Barker J used the terms ―average investor‖ and ―reasonable investor‖.76 In interpreting the meaning of the term ―short-term money market‖ as used in the prospectus, the Judge spoke of the ―intelligent investor‖.77 Later, his Honour spoke of what ―investors reading the prospectus‖ would have taken from it.78 In District Registrar of Companies v Heenan,79 Judge Callaghan considered whether a mis-statement in a prospectus was
―immaterial‖ from the perspective of a ―reasonable investor‖.80 All of these cases
involved prosecutions under s 58 of the Act.
73 Securities Act 1978, s 38E(1)(c) and Securities Regulations 1983, reg 7A and Schedule 3D, cl 18.
74 R v Baxter [1998] 3 NZLR 144 (CA) at 157.
75 R v Rada Corporation Ltd (No 2) [1990] 3 NZLR 453 (HC).76 Ibid, at 465 and 471.
77 Ibid, at 463.
78 Ibid, at 477.
79 District Registrar of Companies v Heenan (1997) 8 NZCLC 261,334 (DC).80 Ibid, at 261,349. The subsequent reference to ―an actual investor‘s standpoint‖ would be
[63] The requirement to draw to an investor‘s attention the existence of any registered prospectus containing information about the same offer of securities suggests that the person reading the prospectus should be treated as the same
―prudent but non-expert person‖ to whom the investment statement is directed.81
The expression ―prudent but non-expert person‖ is consistent with the view of the Davey Committee, back in 1895, when it spoke of the importance of disclosure to an investor of ―average prudence‖. Although the investment statement now serves as the primary marketing document for those wishing to consider making an investment, it was anticipated that the notional investor would have the opportunity to review the prospectus also. In those circumstances, there is no good reason why a
―prudent but non-expert person‖ ought not to be considered as the intended reader of
a prospectus. I proceed on that basis.
problematic if it were to suggest that a particular investor‘s approach might be determinative. The statutory requirements are focussed on the approach of a notional investor.
81 This view is consistent with the select committee report on the Investment Product and Adviser
(Disclosure) Bill. In addressing concerns raised by the New Zealand Law Society, the committee said: ―The bill is not intended to change the substantive law. Statements are currently deemed to be included in an advertisement or registered prospectus if they are contained in any report, memorandum of document which accompanies the advertisement or registered prospectus or is incorporated by reference‖. See Investment Product and Adviser (Disclosure) Bill 1995 (138-2) (select committee report) at iv.
9. The characteristics of the “prudent but non-expert” person
[64] What are the characteristics of the ―prudent but non-expert person‖? For ease of reference, I use the term ―notional investor‖ to refer to such a person, for the purpose of this part of these reasons.
[65] First, the notional investor must fall somewhere between one who is completely risk averse and someone who is prepared to take a high level of risk. The investor could be expected to know that the higher the interest rate offered, the greater the risk of loss.
[66] Second, the investor must be sufficiently intelligent and literate to understand the language employed in the narrative sections of both an investment statement and a prospectus. It must be assumed that such a person will have (or will obtain from an adviser) a general understanding of technical words (such as ―debenture‖) and financial jargon (such as ―roll-over‖). Because of the postulated lack of expertise, the notional investor is expected to focus more on the narrative of the offer documents than on the financial statements.
[67] Third, the statutory scheme contemplates that the notional investor would seek assistance from a financial adviser.82 While not expected to be financially literate (in the sense of being able to read financial statements, to comprehend all aspects of what is disclosed and to understand how the various parts of statements of accounting policies fit together), such a person is likely to have sufficient ability to comprehend competent advice about such matters.
[68] The likely ambit of advice may be important to the basis on which the investor makes an investment decision. The Investment Advisers (Disclosure) Act
1996 was enacted as a companion to the investment statement regime.83 That statute
defined the term ―investment adviser‖ as one who ―in the course of [his or her]
82 Securities Regulations 1983, Schedule 3D, cl 1.
83 See para [56] above. The disclosure regime for investment advisers introduced by the 1996 Act was in force in both 2006 and 2007, when the offer documents in issue were distributed.
business or employment, gives investment advice‖.84 Correspondingly, the term
―investment advice‖ meant a ―recommendation, opinion, or guidance given to a member of the public in relation to buying or selling (or not buying or selling) securities‖.85 Subject to an exception carved out for journalists expressing views in
that capacity,86 a recommendation, opinion or guidance can be communicated in any
form; including through the newspapers or television. A deliberate decision was made not to identify occupational groupings, because to do so might inappropriately exclude a wide range of people who offered investment advice.87
[69] Because it was necessary to put industry norms in place to encourage investment advisers to seek competent advice in areas in which they were inexperienced or unsophisticated,88 the type of adviser to whom the investor was likely to go could not be expected to read and advise on a complicated set of financial accounts.
[70] Finally, the investor would be regarded as one of modest financial means; neither rich nor poor. A middle-income New Zealander may be an apt phrase. While having sufficient funds to obtain some advice about the proposed investment, the person concerned is unlikely to have the financial capacity to obtain detailed accounting advice; much less a forensic analysis of the financial data.
10. The regulatory regime: roles and functions
(a) Introductory comments
[71] In contending that they had reasonable grounds to believe that statements in the offer documents were true, each director says that he was entitled to rely on acts of others involved in the preparation of the documents. Such reliance may be permissible, provided there is nothing that puts a director on notice that further
inquiry is necessary. The statutory definition of the phrase ―due enquiry‖ in s 2B of
84 Investment Advisers (Disclosure) Act 1996, s 2(1), definition of ―investment adviser‖.
85 Ibid, definition of ―investment advice‖.
86 Ibid, definition of ―investment advice‖, para (c)(i).
87 See Investment Product and Adviser (Disclosure) Bill 1995 (138-2) (select committee report) at v.88 See Armitage v Church HC Wellington CIV 2009-485-1952, 27 May 2011 per Dobson J at para
[65].
the Act and the more general reliance provisions set out in s 138 of the Companies
Act 1993 have relevance.89
[72] In the present case, there are five classes of persons on whom the directors contend they relied when approving the offer documents: members of Nathans‘ senior management team, the auditors (Staples Rodway), the trustee (Perpetual), the Registrar of Companies and external advisers, such as lawyers, accountants and business valuers. Some analysis is required of the roles played by directors and those on whom they seek to rely in the prospectus and investment statement preparation process, to determine the extent to which reliance is justifiable.
[73] I emphasise that what follows does not purport to be a full legal analysis. It is more akin to a sketch of the respective roles, against which I can undertake a fact- specific analysis on reliance issues.
(b) Directors and management
[74] Directors direct; managers manage. That is the essential difference between governance and management. Directors establish the policy or rules that are to be implemented by management and put systems in place to ensure their instructions are carried out. In Dairy Containers Ltd v NZI Bank Ltd,90 Thomas J expressed this idea as follows:91
It should not be necessary to restate that it is the fundamental task of the directors to manage the business of the company. Theirs is the power and the responsibility of that management. To manage the company effectively, of course, they must necessarily delegate much of their power to executives of the company, especially in respect of its day to day operations. Although constantly referred to as ―the management‖, the executives‘ powers are delegated powers, subject to the scrutiny and supervision of the directors. Responsibility to manage the company in this primary sense remains firmly with the directors.
89 See also paras [78] and [81] below.
90 Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR 30 (HC) at 79.
91 Ibid, at 79. This passage has been referred to with approval by the Court of Appeal in Mason v
Lewis [2006] 3 NZLR 225 (CA) at [115].
[75] In many small companies, directors fulfil the dual roles of governance and management. In larger enterprises (such as Nathans), the functions are divided. The two approaches are reflected in s 128 of the Companies Act 1993:
128 Management of company
(1) The business and affairs of a company must be managed by, or under the direction or supervision of, the board of the company.
(2) The board of a company has all the powers necessary for managing, and for directing and supervising the management of, the business and affairs of the company.
(3) Subsections (1) and (2) of this section are subject to any modifications, exceptions, or limitations contained in this Act or in the company's constitution.
[76] Directors of finance companies operate in a dynamic business environment in which many difficult decisions of a significant nature must be made promptly, to respond to market pressures. A standard of near perfection is both undesirable and unattainable. The focus is on the range of reasonable courses open to directors, in the circumstances they face at the time a decision is made. That approach is reinforced by one of the purposes set out in the Long Title to the Companies Act
1993:
(d) To encourage efficient and responsible management of companies by allowing directors a wide discretion in matters of business judgment while at the same time providing protection for shareholders and creditors against the abuse of management power; ...
[77] It is the duty of all directors to act in good faith and in the best interests of the particular company.92 Where a company is a wholly-owned subsidiary of another, it is open to its directors, when exercising powers or performing duties as such, to act in the best interests of the holding company, even though that may not be in the best interests of the company. However, that exception applies only if the directors are expressly permitted to do so, by the constitution of the company.93 In this case there is no evidence that the constitution permitted that to be done. Nor, in fact, did any of the directors suggest that they carried out their duties, as directors of Nathans, on
that basis.
92 Companies Act 1993, s 131(1).
93 Ibid, s 131(2).
[78] Any director, when exercising powers or performing duties as a director, is required to exercise the care, diligence and skill that a ―reasonable director‖ would exercise in the same circumstances.94 At face value, the notion of a ―reasonable director‖ does not draw any distinction between those who act in executive or non- executive capacities. However, in determining whether the appropriate degree of care has been applied, ―the nature of the responsibilities undertaken by‖ the particular director can be taken into account.95 The division of responsibilities accords with the general reliance provisions in s 138 of the Companies Act, in that, in particular circumstances, a director is entitled to rely on any other director in performing his or her duties.96
[79] Under the statutory scheme, every director is required to sign a prospectus.97
Section 58 of the Act makes it clear that the responsibility for ensuring that an offer document is not misleading rests on the directors. That is why a prospectus must inform potential investors of the name, address and technical or professional qualifications of any director of the issuer.98 There is no similar requirement for a corporate issuer to disclose the names and qualifications of the company‘s senior management team. That is unsurprising. Those who subscribe for debt securities do so on the basis that the directors named in the prospectus have ultimate control and responsibility for their investment funds. Those who are held out to have appropriate
qualifications and experience are likely to be seen as providing comfort to an investor, who may be investing limited funds to save for his or her retirement. Photographs and profiles of directors are often put into a prospectus or an investment statement to demonstrate to a potential investor that the directors have the necessary qualities and experience to act as their stewards and to safeguard their investment.
[80] So far as financial information is concerned, members of the board have a collective obligation to ensure that proper accounting records are kept.99 They must
correctly record and explain the transactions of the company, enable the financial
94 Ibid, s 137.
95 Ibid, s 137(c).
96 Ibid, s 138(1)(c). However, see Adams v Thrift [1915] 2 Ch 21 (CA) at 24 per Lord Cozens- Hardy MR, 25 per Pickford LJ and 26 per Warrington LJ and Bundle v Davies [1932] NZLR 1097 (SC) at 1099 per Myers CJ, on the limits of such reliance in the reasonable belief context.
97 Securities Act 1978, s 41(1)(b).
98 Securities Regulations 1983, Schedule 2, cl 5(1).
99 Companies Act 1993, s 194(1). See also Securities Act 1978, s 53.
position of the company to be determined with reasonable accuracy at any time, enable the directors to ensure that financial statements of the company comply with s 10 of the Financial Reporting Act 1993 and enable the financial statements to be readily and properly audited.100 After ―due enquiry‖, directors must state, in a prospectus, whether, since the date of the last statement of financial position, there have been any circumstances that ―materially adversely affect the profitability, value of assets or ability to pay liabilities within the next 12 months‖.101 All of those factors suggest a need for more than a basic understanding of accounting principles.102
[81] Although those obligations are cast on directors, both s 2B of the Act and s 138 of the Companies Act 1993 recognise that, in certain circumstances, a director may rely on information from others. Neither s 2B nor s 138 create a defence to a criminal charge. Their relevance is to the adequacies of the inquiries actually made, the information on which the directors relied and the reasonableness of any such reliance.103 By way of recent illustration, in the context of a prosecution of directors under the Financial Reporting Act 1993, Judge Jan Doogue, in Ministry of Economic Development v Feeney,104 used s 138 to aid her inquiry into whether directors of a company took all reasonable and proper steps to ensure that its financial statements complied with that Act.
[82] Senior management will be delegated tasks by the directors. Subject to adequate monitoring of management by the directors or anything that may put a director on notice of the need for further inquiry,105 reliance on information provided by management in their delegated areas of authority will generally be appropriate.
But every reliance inquiry will be fact specific, taking into account both the
100 Ibid.
101 Securities Regulations 1983, Schedule 2, cl 35. See also s 2B of the Act, where ―due enquiry‖ is
defined.
102 See para [402] below.
103 In Paape v Fahey (2005) 9 NZCLC 263,813 (HC) at paras [90] and [91], Ellen France J accepted that s 138 could inform the steps taken by directors in the context of obligations imposed by the
Securities Act 1978.
104 Ministry of Economic Development v Feeney (2010) 10 NZCLC 264,715 (DC). This decision was discussed in some detail in Australian Securities and Investments Commission v Healey [2011] FCA
717 at para [151] and following.
105 Securities Act 1978, s 2B(1) and Companies Act 1993, s 138(2)(b) and (c).
obligations and responsibilities of particular directors and the nature of the tasks delegated to members of the management team.
[83] It is axiomatic that a director of a finance company will be assumed to have the ability to read and understand financial statements and the way in which assets and liabilities are classified. For example, a director of a finance company should be expected to know that a ―current asset‖ is one expected to be realised within one year.106
[84] Without those basic skills, it would not be possible for directors to monitor and guide the finance company‘s business.107 Occasionally, even directors with a significant accounting background will be entitled to rely on specialists who, in the context of the way in which the company‘s financial reporting is undertaken, can be expected to have explored a particular problem in greater detail and to have provided advice on which such a director might reasonably rely.108
[85] Directors need to have the characteristics, skills and experience to which I have referred to enable the fortunes of the company to be guided and for the management of the company to be monitored. Those obligations are cast upon all categories of directors, not just executive directors.109
[86] That is the context in which the directors‘ claims of reliance must be assessed. That approach is consistent with the terms of both s 2B of the Act and s 138 of the Companies Act 1993. Both of those provisions envisage the possibility of the need for further inquiry by a director, on the basis of information already held or incomplete information on which further explanation is required. The protections
afforded by s 2B and s 138 will be forfeited if appropriate inquiry is not made.
106 The term ―current assets‖ is defined by the Securities Regulations 1983, reg 2(1) in this way,
reflecting orthodox and prevailing accounting standards.
107 See, generally Davidson v Registrar of Companies [2011] 1 NZLR 542 (HC) at para [121] and
Australian Securities and Investments Commission v Healey, at para [124]. See also para [401] below.
108 See, for example, Ministry of Economic Development v Feeney, at para [64] in the context of the transitional period from the Generally Accepted Accounting Principles standards to the International
Financial Reporting Standards.
109 Australian Securities and Investments Commission v Macdonald (No 11) (2009) 230 FLR 1 at para [255] per Gzell J; approved by Middleton J in Australian Securities and Investments Commission v Healey at para [171]. See also Mason v Lewis [2006] 3 NZLR 225 (CA) at para [83] stating that ―The days of sleeping directors ... are long gone‖.
[87] Such requirements are not unduly oppressive; nor could they be said to act as a disincentive to qualified persons acting as directors of finance companies.110 They represent no more than the basic level of understanding needed to run a finance company, which any investor would expect a director to have.111
(c) The auditors
[88] An auditor is appointed at an annual general meeting of a company to report to the shareholders on the directors‘ stewardship of the company‘s assets.112 That report must state the work undertaken, the scope and limitations of the audit, the existence of any other relationship the auditor has with the reporting entity or any of its subsidiaries, whether all information and explanations requested have been provided, whether proper accounting records have been kept and whether financial statements comply with generally accepted accounting practice.113 The auditor must then express an opinion on whether the financial statements (and any group financial statements) give a true and fair view of the matters to which they relate and, if they do not, the express respects in which they fail to do so.114
[89] The Act and Regulations require audit functions to be performed by
―qualified auditors‖ as defined.115 In addition to the auditors‘ usual reporting requirements, an audit opinion completed for the purpose of a prospectus must state whether the financial statements and group financial statements comply with specified parts of the Regulations,116 whether the relevant financial statements comply with generally accepted accounting practice and whether they give a true and fair view of the state of affairs of the entity and of its results and cash flows, for the period to which they relate.117 The auditors‘ report must be included in the
prospectus.118
110 See also R v Steigrad [2011] NZCA 304 at para [114].
111 In relation to directors‘ principal duties, see, generally Daniels v Anderson (1995) 37 NSWLR 438 (CA) at 501-505 and Francis v United Jersey Bank 432 A 2d 814 (NJ 1981) at 821-823.
112 Companies Act 1993, ss 196 and 205.
113 Financial Reporting Act 1993, s16(1)(a)-(f).
114 Ibid, s 16(1)(g).
115 Securities Act 1978, s 2C, for the meaning of ―qualified auditor‖.
116 Securities Act 1973, s 50(1) and (2).
117 Securities Regulations 1983, Schedule 2, cl 36(1)(f).118 Ibid, cl 36(1).
[90] The auditor must send to the trustee a copy of any report furnished to the company issuing the prospectus.119 If the auditor becomes aware of any matter that is relevant to the exercise or performance of the powers or duties of the trustee, it must report in writing to the issuer, sending a copy of the report to the trustee. If requested by the trustee, the auditors must also furnish a report to the trustee on any aspect within the auditors‘ knowledge relevant to the exercise or performance of the powers or duties of the trustee.120
[91] Usually, auditors will obtain a ―representation letter‖ from the directors that sets out facts on which the auditors have sought assistance and on which they have relied. Having said that, the auditors‘ functions necessarily carry with them a need to carry out independent inquiries (usually through sampling techniques) to ascertain whether the information provided in the financial statements of the issuer do, in fact, provide a true and fair view of the company‘s position.
(d) The trustee
[92] For a debt security, a trustee is appointed to protect the interests of public investors. The trustee‘s duties arise primarily from the terms of the trust deed under which it is appointed. In the trust deed of 15 November 2001, Nathans promised the trustee that it would duly and punctually observe, perform and fulfil all of the provisions of the trust deed that were binding on it. The obligation was reinforced by the form of the certificates required from directors on a quarterly basis. One of those (Schedule 3) was directed (among other things) to any materially adverse circumstances that had come to the attention of the directors; another (Schedule 4) was concerned with liquidity. The directors had ultimate responsibility for ensuring that accurate information was contained in those certificates. They knew that the trustee carried out its functions in reliance on what they reported. In this case, the chief financial officer of Nathans prepared mirror reports for the board, on which the
directors say they relied in signing the quarterly reporting certificates. The extent to
119 Securities Act 1978, s 50(1).
120 Ibid, s 50(3).
which they were entitled, without further inquiry, to rely on the certificate given to them by the chief financial officer is in issue.121
[93] By relying on certificates that directors provide, a trustee is able to exercise reasonable diligence, both to ascertain whether or not there has been any breach of the terms of the deed and whether or not the assets are sufficient or likely to be sufficient to pay maturing debenture stock. The provision of regular certificates avoids the need for the trustee to monitor the issuer‘s affairs in a more invasive manner.
[94] Once put on inquiry of potential problems, it is open for the trustee to obtain further factual information from the issuer. If, after ―due enquiry‖,122 a trustee is of the opinion that the issuer is unlikely to be able to pay all money owing in respect of the securities when it falls due for payment, it may apply to this Court for an order (among other things) imposing such restrictions on the activities of the issuer as may be necessary for the protection of the interests of security holders, restraining
payment of any money by the issuer to security holders or any class of them or appointing a receiver or manager.123
[95] The trustee also has obligations of disclosure to the Registrar of Companies, if it were to hold information that, for example, led it to the opinion that the issuer was (or was likely to become) insolvent or was in serious financial difficulties.124
The requirement for disclosure to the Registrar assists the latter to determine (for example) whether he or she should (in a wider public interest) exercise the power to declare a corporation ―at risk‖.125
[96] Before advising the Registrar, the trustee is required to take reasonable steps to inform the company both of its intention to disclose and the nature of the
121 For part of the period in question, Mr Doolan provided certificates for the board, as acting chief financial officer during an interregnum. See para [139] below.
122 As defined in Securities Act 1978, s 2B.
123 Securities Act 1978, s 49(1) and (3)(b), (e) and (f).
124 Corporations (Investigation and Management) Act 1989, s 11(a).125 Ibid, s 30.
information.126 Because of the need to act in the public interest, a trustee that discloses such information in good faith is immune from any form of proceeding.127
(e) Registrar of Companies
[97] In general terms, the Registrar of Companies is an administrative functionary whose task is to receive and register prospectuses and related documentation. The Registrar must register every prospectus delivered to him unless it does not comply with the Act, contains any misdescription or error, matter not clearly legible or contrary to law, or if the correct fee is not paid.128
30 September 2006.
[414] The minutes of the 20 November 2006 meeting reveal that:
(a) There was a focus on the state of the inter-company debts. The board was advised that plans to reduce the inter-company debt were in place. While Mr Doolan and Mr Moses already knew this from their positions on the VTL board, the information is likely to have come to Mr Young‘s attention through the papers. The plans involved
―divestiture of major assets‖ by VTL.233 The board recorded ―that it
wished to consider details of factors contributing to‖ the increase in the inter-company indebtedness. Mr Bayer was asked to provide a breakdown of ―capitalized intercompany interest‖ for circulation to the directors.
(b) Mr Leong‘s report of 1 November 2006 revealed that, as at 30
September 2006, the inter-company debts totalled $88.21 million and represented 58.2% of total finance receivables. There had been an increase of $3.45 million since 31 August 2006. The increase was said to be ―partly due to capitalising inter-company interest, interest
subsidies of related parties and machine lease payments‖. The board
232 See para [326] above.
233 See paras [335] and [336] above.
was also told that ―VTL related advances‖ being defined as ―inter- company advances and loans to its [master franchisees] and machine lessors (but excluding [All Seasons] related advances)‖234 accounted for 89.8% of total receivables. The September 2006 figure for inter- company advances represented an increase of $8.58 million in the three months from balance date, 30 June 2006.
[415] The next meeting of the Nathans‘ board was scheduled for 21 December
2006. The board papers for that meeting were not available to directors of Nathans
before the exchanges leading to Mr Hotchin‘s ―no cash will come in‖ email, of 1
December 2006.235 They were circulated sometime in December. It appears likely that they were circulated before 13 December 2006, though on issues relating to the inter-company and VTL business-related advances, that may not matter.236
[416] The October board papers, for the December meeting, contained the minutes of the 20 November 2006 meeting and the following additional information:
(a) A request by Mr Bayer to Mr Doolan in a memorandum dated
7 December 2006, for an increase in the facility limits for either
24seven Vending (Australia) Ltd or 24seven Vending Pty Ltd, to fund
―continued growth in this particular market‖. An increase of between
$4 million and $5 million was sought. The then current facility was
$10 million.
(b) The inter-company debt had increased from $79.63 million (as at 30
June 2006) to $90.13 million (as at 31 October 2006). The corresponding figure to 30 September 2006 was $88.21 million. Expressed as percentages of total receivables the September and
October amounts were 58.2% and 58.8% respectively.
234 This calculation does not equate exactly (for definitional reasons) to the calculations I have made in respect of what I have defined as ―VTL business-related debts‖ – though the figures are probably close enough for rough comparison.
235 See paras [171]-[183] above.
236 See paras [414](b), [416](b) and (c) below.
(c) The total of VTL business-related debts (excluding loans to operating franchisees) as at 31 October 2006 was $129.82 million, accounting for 84.7% of total finance receivables; this compares with
$127.81 million and 84.4% as at 30 September 2006.
(d)The significant lending to VTL master franchisees and operators meant that Nathans remained exposed to a ―funding mismatch‖.
(e) A loan of $750,000 to AVS had fallen due for repayment on
14 August 2006. While approval had been given for a fresh facility to be granted, none had been documented at the time the board papers were circulated.237 The ―NFL Loan Arrears Report‖ recorded that AVS loan as having expired.
[417] This information made it plain that not only could the existing inter-company debts not be repaid but that a further sum of between $4 million and $5 million was being sought to fund continued growth in Australia; something which, on the face of it, was inconsistent with the divestment strategy discussed at the 20 November 2006 meeting.238 That was provided to the directors in the context both of information that part of the AVS loan had fallen into arrears and the marked increase in the VTL business-related indebtedness between 30 June 2006 and 31 October 2006.239
[418] Against that background, I consider whether the directors had reasonable grounds to believe the statements in the investment statement and prospectus were not misleading.
[419] The first issue is generic in nature. It concerns the ability of directors of an issuer to rely on others involved in the preparation of an investment statement and prospectus for the purpose of complying with their own statutory duties. While questions of degree arise and may result in more difficult judgments in other cases, I
am satisfied that any ―reliance‖ of the type advanced by the directors in this case
237 The broad thrust of the reasons why a renewed facility had not been granted are set out at paras
[303]-[308] above.
238 See para [414](a) above. See also para [355] above.
239 See para [416](c) and (e) above.
cannot result in reasonable grounds to believe that the statements in the investment statement and prospectus were not misleading.
[420] The statutory duty for ensuring that offer documents go into the market without misleading statements rests on directors of the issuer.240 Directors have a non-delegable duty to form their own opinions on that issue, in reliance on information provided by others that they have no reason to suspect may be wrong. The problem for the directors, in this particular case, is that they, in effect, purported to delegate to senior management the task of determining whether the investment
statement and prospectus were ―compliant‖ with regulatory requirements and failed to bring independent minds to bear on the topic. Their failure to do that was particularly surprising given the Securities Commission‘s earlier report on disclosure by finance companies and the subsequent correspondence with Nathans.241
[421] There was a fundamental failure, on the part of all directors, to review the content of the offer documents and to ask themselves whether the information conveyed presented, to a prudent but non-expert person, an accurate impression of Nathans‘ business and the associated risks. That exercise should have been undertaken by excluding their own insider knowledge. That is one of the reasons why a collective approach at a board meeting would likely have resulted in a different outcome. A discussion among the directors, properly led by the chairman, was likely to tease out a number of issues of concern.
[422] While it was fair for the directors to rely on the auditors to check aspects of the company‘s financial statements and to ensure that technical standards were fully met in relation to accounting policies, the accounts remained those of the directors and they had their own obligation to be satisfied of their content when signed.242 By way of example, to which I shall refer in the context of the liquidity issue, it ought to have been obvious to Mr Moses, Mr Doolan and Mr Young that the classification of
all or part of the inter-company indebtedness under ―current assets‖ in the statement
240 Securities Act 1978, s 58(1) and (3); set out at para [23] above.
241 See generally, paras [75]-[87] (directors‘ duties), [171]-[185] (email correspondence regarding risk section of investment statement and prospectus), and [395]-[404] (particular responsibilities of individual directors) above.
242 See para [80] above.
of financial position was an error; irrespective of whether the auditors should take responsibility for the absence of a note making clear that the liquidity profile was prepared on a maturities basis.243
[423] It was not open to the directors to believe that Mr Steytler and the solicitors had an obligation to ensure ―compliance‖. As recognised by Mr Hotchin, a decision on the extent of disclosure on risk was for the board to make, not management.
[424] Mr Moses, Mr Doolan and Mr Young have all emphasised that they did not receive the final advice provided by Minter Ellison, about the way in which the extent of the inter-company loans should be addressed in the risk section of the investment statement and prospectus. The solicitors had suggested that the directors may wish to describe the inter-company borrowings as ―very significant‖ or ―almost
half‖.244 The three directors say that they would have followed advice to that effect.
[425] On analysis, Mr Steytler‘s inadvertent failure to forward the final email in the sequence had no impact on the state of the directors‘ knowledge at the time they approved the risk section of each of those documents:
(a) Two days before the solicitors provided final advice at 2.05pm on
1 December 2006,245 Mr Steytler had sent an email to all four Nathans directors, Mr Stevens, Ms Short, Mr Leong and Mr Bayer. He attached a version of the investment statement that contained a statement under the subheading ―VTL Insolvency‖ in the proposed
―Risk‖ section of the investment statement:
[Nathans] provides financial accommodation to its parent company VTL and to VTL subsidiaries. As at 30 June 2006 these advances totalled $79,630,043 making up a significant portion of [Nathans‘] current assets (46.2%) and are secured. Advances to VTL and its subsidiaries have been made on a commercial arms length basis, normally for terms no longer than 12 months.
243 See para [402] above.
244 See para [183] above.
245 See paras [182] and [183] above.
(b)From the information available to them from either the September or October 2006 board papers, the directors knew that the total inter- company debts was in the vicinity of $89 million, about 58.5% of total receivables. They also knew that the VTL business-related debts totalled around $128 million, representing about 84% of total finance
receivables.246 By way of comparison, the 30 June 2006 accounts,
showed the inter-company debt at $79,630,043.
(c) If the directors had made inquiry to ascertain the amount outstanding at the end of November 2006, when approving the prospectus, they would have found that the total amount of inter-company debts had increased to $92.62 million; about 59.5% of Nathans‘ total finance receivables.
[426] From the information actually (or readily, on due enquiry) available to the Nathans‘ directors, any difference between Mr Steytler‘s suggestion of using the word ―significant‖ to explain the extent of inter-company borrowing, compared with the expression ―very significant‖ or ―almost half‖ pales into insignificance. The expression in dollar (or percentage) terms as at 30 June 2006 bore little resemblance to the actual position as at December 2006.
[427] Mr Moses, Mr Doolan and Mr Young purported to place reliance on what they had been told by Mr Steytler and Minter Ellison on this issue. Any such reliance was misplaced. Minter Ellison, as the company‘s solicitors, provided advice based on primary facts given to them by the client. There is no evidence that Minter Ellison was ever given updated figures for the inter-company advances, whether as at 30 September, 31 October or 30 November 2006. That is evidenced by the suggestion that the words ―almost half‖ be inserted into the ―Risk‖ section of the two offer documents. Had updated figures been provided the percentage of inter-
company advances to total finance receivables would have exceeded 50%.
246 See para [415](b) and (c) above.
[428] The role of the trustee and the Registrar was even more limited.247 The limited review carried out by each of those parties for the purpose of complying with their particular statutory and contractual duties could not absolve the directors from compliance with their own.
[429] Even a cursory analysis of the narrative of the investment statement and prospectus should have led the directors to the view that the impression conveyed by it was at odds with the real position, as they knew it to be. There are no reasonable grounds on which the directors could have believed that the impression conveyed by the narrative of the prospectus was not misleading.
[430] I now deal with the specific grounds on which the directors contend that they had a rational basis for believing the statements were true.
[431] There were no reasonable grounds on which the directors could believe that lending to VTL and its subsidiaries were made on normal commercial terms, usually for periods of no more than 12 months. Nor were there such grounds for believing that the loans were managed in a manner consistent with those of third party borrowers.
[432] As at the date on which the investment statement and prospectus were distributed, the directors of Nathans knew there was no reasonable prospect that inter-company debts could be repaid without VTL selling all or some of its business units. Nor was there any possibility of IVL or AVS repaying their debts without their businesses being sold in conjunction with VTL business units.248 The directors were aware of inconsistent strategies being undertaken by VTL to obtain repayment of the debt. Leaving the Australian market to one side (as it was discussed in greater detail just before Christmas 2006) the directors were aware both of the ―divestment‖ policy
and the various acquisitions of interests in businesses in the United States. They were also aware of a significant increase in the inter-company debt since 30 June
2006.
247 See paras [92]-[96] (trustee) and [97] and [98] (Registrar of Companies) above.
248 See paras [216] and [217] above.
[433] It was disingenuous for the directors to place weight on the suggestion that the impugned statements were literally true. The directors were aware that the money received would be used primarily as working capital for VTL and that was not disclosed.249 Save in rare circumstances, a commercially driven lender is unlikely to capitalise the interest or extend the amount or term of a loan to an arm‘s length third party, when it knows that the borrower cannot afford to pay either
interest or principal from existing business revenue. At the least, it would be necessary to disclose in unequivocal terms that that state of affairs existed.250
[434] Generic statements about good governance and credit management processes fall into the same category. Strong corporate governance does not involve the delegation of strategic decisions about a company‘s future to its parent, particularly when the subsidiary is soliciting funds from the public for the ostensible purpose of developing its business as a finance company. So far as ―robust credit management‖ was concerned, the directors were aware of the cursory basis on which applications for finance and/or roll-overs were made in cases involving VTL, IVL and AVS. The degree of scrutiny given to third party borrowers far exceeded those relating to VTL, IVL and AVS, notwithstanding that the extant credit policy did not differentiate
between different types of borrowers.251
[435] I am prepared to assume (without deciding the point) that the directors were entitled, at least so far as the liquidity profile was concerned, to rely on the auditors review of the accounting policies and the absence of any indication from them that a note should be added to deal with the ―maturity date‖ basis on which the liquidity profile had been prepared. I am not prepared to make an unequivocal finding in favour of the directors on this point because of my concerns that the directors were on notice as a result of the way in which part or all of the inter-company advances were classified as a ―current asset‖ in the statement of financial position. In light of other findings, a detailed consideration of this issue is rendered otiose.
[436] So far as the suggestion that VTL supported Nathans was concerned, the directors had no reasonable basis to believe that VTL, as at the date on which the
249 See para [219] above.
250 See para [218] above.
251 See paras [220]-[222] above.
prospectus and investment statement was registered or in the foreseeable future, would have sufficient funds to support Nathans in the event of financial adversity. As previously indicated, Nathans supported VTL.252 The directors‘ assessment of VTL‘s prospects of receiving sufficient funds to make any significant impact on the amounts owing to Nathans in respect of inter-company debts (leaving to one side the IVL and AVS debts) was hopelessly optimistic.
[437] Because the ―growth and diversification‖ of the commercial lending book point is no more than the other side of the coin involving failure to disclose the true extent of the VTL business-related indebtedness, I see no reason to address that issue independently.
(iii) As at 29 March 2007
[438] By the time the extension certificate was signed there had been one important development that could have effected payment of about 10% of the inter-company debt. That development arose out of the sale of shares in VTL to Messrs Halpern and Denny that was settled on or about 19 January 2007.253 The relevance of receipt of the Halpern and Denny purchase moneys lay in the ability that directors of VTL (now including Mr Young) had to provide some financial support to Nathans if
circumstances so required. The question is whether receipt of those moneys could form a reasonable basis for the directors to believe that VTL was in a position to support Nathans if necessary, thereby rendering a previously misleading statement true.
[439] I do not accept that receipt of the moneys provides a reasonable belief for the view that the earlier statements about VTL‘s ability to support Nathans were no longer misleading. First, the moneys were not ―earmarked‖ for Nathans, in a legal sense. Indeed, while not relevant for present purposes, they were never used for Nathans‘ benefit until after receivership. Second, while a relatively large sum, it was,
as at January 2007, about 10% of the total inter-company debt and a much lesser
252 See para [224] above.
253 See para [293] above.
percentage of the VTL business-related debts. If Nathans struck troubled waters the sum of $10.6 million would not go far in alleviating its financial situation.
[440] At the time the extension certificate was registered, the misleading statements arising out of the original prospectus remained. My findings on the lack of reasonable grounds for belief that those statements were not misleading as at
13 December 2006 apply equally as at 29 March 2007. The obligation to monitor the position to ensure a prospectus and investment statement portray the real position of the company applies.254 No reasonable efforts were made to comply with that obligation.
[441] I have held that there were two additional misleading statements, arising out of the two points certified by both Mr Doolan and Mr Hotchin.255 To determine the grounds for any belief that those statements were true, as at 29 March 2007, it is necessary to consider what occurred at board meetings prior to that date.
[442] Mr Young attended his first meeting of the VTL board on 19 December 2006. On the same day a strategy meeting was held at which, among other things, Nathans‘ future was discussed. The content of the board papers and the discussion at those two meetings has already been summarised.256
[443] In addition to the matters discussed at those meetings, VTL had made three further acquisitions in the United States, all of which had required funding from Nathans: Phoenix Snack Attack, Artic Vending and Aramark. These were said to have been generating sales of $1.5 million, $1.1 million and $200,000 respectively. The Nationwide acquisition was not far advanced. The possibility of listing Nathans in either New Zealand or Australia had not been progressed.
[444] A further meeting of the Nathans‘ board was also held on 27 February 2007. The papers for that meeting indicated that a paper on the topic of establishing subsidiaries of Nathans in Australia and the United States for circulation to directors
had been put ―on hold‖.
254 R v Steigrad [2011] NZCA 304 at para [114].
255 See paras [238]-[241] above.
256 See paras [345] and [347] above.
[445] Directors were told that IVL loans were about to mature: $9.5 million on 22
April 2007, $697,000 on 30 June 2007, $US5.4 million on 1 September 2007 and
$2.4 million on 30 September 2007. Mr Young‘s notes of that meeting indicate that a management meeting was to be held on 1 March 2007 to consider this issue, with Mr Doolan to review the possibility of a roll-over. By this time, IVL was trading at the behest of VTL and had no independent management to make decisions on issues of that type.
[446] In addition, Mr Leong reported that the loan of $AUD750,000 to AVS had expired on 14 August 2006, some six months earlier. Though the loan had ―been approved for roll-over‖, that was ―currently being documented‖. On that issue, Mr Young noted that Mr Leong advised that initially Mr Seymour had wanted interest support before signing any roll-over document, but that issue had since been resolved between Mr Davies and Mr Seymour.
[447] After the 27 February 2007 board meeting, the next meeting of the VTL
board was scheduled for 29 March 2007. However, it was deferred until 11 April
2007. Therefore, the VTL board did not meet between 27 February and the date on which the extension certificate was signed. I have been unable to locate any evidence suggesting that the directors made a considered decision about whether the extension certificate should be signed.
[448] I found that the extension certificate itself was misleading in two respects:
(a) It stated that there had been no material and adverse change in the financial position of Nathans since the audited accounts for the year ended 30 June 2006, when that was not the case.257
(b)There was no reference to a significant decrease in net cash flow that was known to the directors at the time the extension certificate was
registered.258
257 See para [240] above.
258 See para [241] above.
[449] The two aspects in which I have held the extension certificate to be misleading arise from information actually before the board at the time the certificate was signed. All directors knew of the true position or, with reasonable diligence, could have ascertained it. As there was no reasonable attempt to ascertain the true position, there can be no reasonable grounds for believing that those material omissions did not misrepresent the true state of Nathans‘ financial position.
[450] In any event, by the end of January 2007, the inter-company advances had increased to about $98 million. As at 31 March 2007 they stood at about
$104 million. Irrespective of the precise figures available to directors as at 29 March
2007, the difference between those two sums was immaterial.
(iv) As at 14 May 2007
[451] The minutes of VTL‘s meeting of 11 April 2007 record that representatives of the Companies Office were inquiring into Chancery‘s situation and a peer review of the Cole-Baker valuations of February and March 2007 was to be undertaken by KPMG. Other correspondence produced in evidence reveals that the issue raised by the Registrar of Companies related to the question whether a proposed transaction involving a loan to NZ Vending Investments Ltd (another VTL company) in a sum of over $16 million had been made on commercial arm‘s length terms and, if not, whether a subordinated guarantee by VTL of bond holders‘ debts would solve the problem. There had earlier been a difficulty in relation to Chancery‘s ability to pay debts as they fell due, evidenced by the quarterly payments made by Nathans in late
2006.
[452] While it is apparent, from reports given by Mr Stevens and Mr Hotchin to the VTL board, that many discussions were underway in an endeavour to sell parts of the VTL business to generate cash, from an objective standpoint, none of those projects had reached such a state of maturity that directors could safely rely on substantial proceeds flowing to VTL in the foreseeable future as a result of any sales. The contradictory strategies reported in advance of the 27 February 2007 VTL meeting made it clear that there was no coherent approach being taken. By that time, the
term ―strategy‖ was a misnomer.259 Although two reports had been received from Mr Cole-Baker in relation to inquiries from Chancery‘s trustee, on balance they could not have been given any real weight given the real position known to the directors at that stage.260
[453] The words used in the 14 May 2007 letter created a false impression of a successful finance company that had never had any problems with impaired debt because of the strong level of corporate governance and robust credit assessment processes employed by it. In addition, the notion that Nathans was not lending in
―higher risk‖ markets was hidden by the restriction of that statement to ―consumer areas‖.261 It was inevitable that impairment of the three major loans would have required reconsideration as at the end of the 2007 financial year.262 In those circumstances, there was no reasonable basis on which the directors could have formed a belief that the statements in the 14 May 2007 letter were not misleading.
(v) As at 6 August 2007
[454] During this period the Bacon Whitney transaction263 was moving from an embryonic stage to a formal offer. In my view, the directors were pinning their hopes on this transaction as a ―saviour‖ for both VTL and Nathans. There was no reasonable basis for that view. There were no realistic prospects of a significant cash injection in the foreseeable future and the structure of the transaction was more likely to benefit the Halpern and Denny interests. In addition, in June 2007, Mr Bayer had advised the board that liquid funds were diminishing relatively quickly.264 By this stage the directors actions were closer to blind faith as opposed to hopeless optimism.
[455] The directors‘ beliefs that the 6 August 2007 letter was not misleading had two bases. The first was founded on the (favourable to the directors) proposition that
the transaction could have promptly proceeded in the form in which it was couched
259 See para [355] above.
260 Compare with paras [388]-[390] above.
261 See para [246] and [248] above.
262 See para [249] above.
263 See paras [294]-[298] above.264 See para [266] above.
in the ―binding letter of intent‖ of 26 July 2007. The Fidelco report was said to give credence to this view.265 But, as mentioned earlier,266 there was no immediate cash payable to VTL. The purchase price was to be met by way of convertible note. Only
5% of the convertible note would be paid each year (about $US3.5 million per annum) based on the entitlement to 50% of the total interest that became payable after six months. In addition, the options to require VTL to purchase some of the shares in Bacon Whitney owned by Halpern and Denny interests were not favourable to VTL.
[456] The second is referable to the value of the transaction to VTL. Mr Graham was instructed to obtain information and to prepare a report for the Ministry of Economic Development. The purpose was to provide a financial assessment of VTL, on the basis of which the Registrar of Companies could make decisions about any steps he may wish to take, whether under the Corporations (Investigation and Management) Act 1989, or otherwise. The critical issue involved the VTL groups‘
―actual‖ EBITDA267 that had been calculated in the Fidelco valuation. Mr Graham
was unable to verify the calculation and was concerned that it was based on forecasts rather than historical data. The Grant Samuel report268 was also pessimistic about this transaction.
[457] It is clear that EBITDA information was not conveyed to Mr Graham, although Mr Tappet, of Fidelco, appears to have provided some data to Mr Hotchin by email dated 6 August 2007. Mr Hotchin sent that information to Mr Doolan the following day and he passed it on to Mr Bayer. Irrespective of the fault in not providing the information to Mr Graham, it is clear from Mr Tappet‘s email that the franchising sales summaries and revenue figures had been supplied through VTL and SAG. Mr Tappet held no independently verified information.
[458] The Bacon Whitney transaction had problematic features of the type already outlined. As at 6 August 2007, there is no evidence that the three accused had dug
any deeper into the transaction or to the valuation obtained from Fidelco. Without
265 See para [392](a) above.
266 See paras [295] and [297] above.
267 Earnings Before Income Tax Depreciation and Amortization.268 See para [392](b) above.
having enquired further about the benefits said to flow to VTL from the proposed transactions, there was no reasonable basis for the directors to believe that this transaction would save Nathans by providing funds to repay or substantially reduce the inter-company debt within a short time.
[459] The directors had no reasonable grounds to believe that the statements made in the 6 August 2007 letter, with regard to involvement in commercial lending were true. It is plain that they omitted a material particular, namely the extent and nature of Nathans‘ lending to related parties and parties associated with Nathans‘ parent. By August 2007, the inter-company indebtedness was approximately $108 million. Those were facts known to the directors or readily available to them. The liquidity position was also deteriorating significantly, as had been reported in June by Mr Bayer.
22. Conclusion
[460] For those reasons, I returned the verdicts set out in para [4] above on 8 July
2011.
P R Heath J
Delivered at 10.00am on 8 July 2011
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