Directors' personal liability for misleading and deceptive conduct in relation to shares

By Michael Legg and Dean Jordan.

Key Points:
Section 1041H can be employed against not only a corporation but also its directors and officers in their personal capacity.

A core prohibition in the Corporations Act 2001 (Cth) is section 1041H which provides "A person must not, in this jurisdiction, engage in conduct, in relation to a financial product or a financial service, that is misleading or deceptive or is likely to mislead or deceive". The provision has historically had a wide application and been relied upon by a variety of plaintiffs including the Australian Securities and Investments Commission (ASIC) and shareholders.

The utility of section 1041H was seriously diminished by the decision in ASIC v Citrofresh International Ltd (2007) 164 FCR 333. The decision was appealed to the Full Federal Court in ASIC v Narain (2008) 66 ACSR 688 which had to consider two important questions:

• is the conduct of publishing a written statement made "in relation to" a financial product (shares) only if the statement refers to those shares?; and
• is an officer of a company personally liable for a contravention of section 1041H if that officer prepares the relevant statement that he fully intends to be published, but does not publish himself, instead instructing the company secretary to do so?

The Full Federal Court answered "no" to the first question, the words "in relation to" have a wide meaning so that an indirect or less than substantial connection is sufficient, and "yes" to the second question, an officer can be personally liable in the above circumstances.

The Full Federal Court's decision reinstated the broad application of section 1041H and confirmed that the provision can be employed against not only a corporation but also its directors and officers in their personal capacity.

The Citrofresh decision

On 27 September 2005, Citrofresh International Ltd sent an announcement to the ASX stating that in a "landmark" test result, Citrofresh demonstrated significant virucidal activity against four major viruses including HIV/AIDS. Shortly after the release of the announcement to the market, the price of the company’s shares increased from 22.5¢ to a high of 70¢ before trading was halted. In response to an ASX query, the company made a further announcement on 29 September 2005. This announcement stated that Citrofresh is not a vaccine and is not a cure for HIV. The shares fell to $0.295.

The text of the announcement was approved by Mr Ravi Narain, who was chief executive officer of the company. He participated in the preparation and drafting of the announcement with two external consultants, approved its contents and directed the company’s secretary to send the announcement to the ASX. Mr Narain distributed a draft version of the announcement to the company's board members but in doing so sought the board's comments but not authorisation or approval for publishing the announcement.

ASIC brought proceedings against the company and Mr Narain seeking declarations against both of them that they had engaged in misleading and deceptive conduct in contravention of section 1041H in particular by making statements such as "[CTF] can now offer a global solution to reduce and eventually stop the spread of [HIV] using Citrofresh."

The company consented to the making of the orders against it but Mr Narain defended the proceedings. The Federal Court at first instance dismissed the proceedings against Mr Narain for two reasons:

• Mr Narain did not engage in conduct "in relation to" a financial product. The primary judge was of the view that the statements in the announcement on which the ASIC relied were not made in relation to shares in the company but were made in relation to the company itself or to a product manufactured and sold by it.
• notwithstanding Mr Narain’s role in the preparation and transmission of the announcement, as he did not actually publish the statements, he was not in breach of section 1041H.

The ramification of the first finding was that a very clear and direct nexus between misleading conduct and a financial product, such as shares, is needed for section 1041H to be applicable. If correct, this would allow liability to be sidestepped by making statements about the company or its business rather than its impact on the share price. For example, on this view, it would not be a contravention of section 1041H to incorrectly state "The company has struck gold" (as it would not be a statement in relation to a financial product) but it would be a contravention if it said "Buy our shares because we have struck gold."

The ramification of the second finding was that an officer could avoid personal liability by interposing an innocent agent between the preparation of a misleading statement and the sending of that statement to the ASX.

Reversed on appeal - the Full Federal Court decision

ASIC appealed to the Full Federal Court. All three judges agreed that the decision at first instance should be reversed on both issues.

The Full Federal Court found that the words "in relation to" are to be interpreted widely, and that their meaning will be informed by the context in which they are used. While these words signify the need for there to be some relationship or correlation between the two subject matters that are specified, there will always be a question of degree as to how close the relationship between those matters must be and whether a less direct or less substantial connection will be sufficient.

The Full Federal Court examined the context of section 1041H, including that it was to operate as a general prohibition, was to ensure that participants in the market for financial products and financial services acted with integrity and honesty and that consumers were adequately protected. On the facts of the case, the Court concluded that the words "in relation to" operated when the connection between the misleading statement and the financial product (share) was indirect or less than substantial.

In relation to the second issue, although an officer is an organ of the corporation, the officer's actions can result in both personal and corporate liability. In this case, the Full Court found that the actions of the company’s secretary were ministerial as an organ of the company or as agent of Mr Narain so he was not, but that Mr Narain was, personally liable. Justice Finkelstein explained that:

"The real culprit, however, is not the individual who sent the release to the ASX; in many cases that person might just be an office worker. It is the person in authority who, with knowledge of its contents, gave the instruction that the release be sent to the ASX for publication."

Conclusion

Section 1041H will continue to have a wide application because, amongst other things, the words "in relation to" were broadly interpreted so as to capture a wide range of conduct linked to shares and the provision could be employed against not only a corporation but also its directors and officers in their personal capacity.

For further information, please contact Dean Jordan and Michael Legg.