Those temporary changes ended on 23 March 2021. On 17 February 2021, the Federal Treasurer announced that this recommendation will be implemented. At the time of writing, a Bill implementing the proposed changes had passed through the House of Representatives but had been referred by the Senate to the Senate Economics References Committee for further consideration, which must report by 30 June. Consequently, we don't currently know whether the Bill will be passed and in what form and when the changes it proposes will commence. In our third deep dive into the future of class actions, we will look at the developments that led to these proposed changes, particularly the Parliamentary Inquiry.
Continuous disclosure: an overview
The continuous disclosure laws are an important feature of the shareholder class action landscape. To make sure everyone's on the same page, let's briefly recap what the continuous disclosure laws are.
Chapter 6CA of the Corporations Act contains provisions which require entities listed on the ASX to disclose certain information to investors. These are commonly referred to as the continuous disclosure provisions, and they work in tandem with the ASX's listing rules. Their purpose is to keep investors informed about matters that may affect their investment decisions. So, what information must listed entities disclose to investors? That's sometimes a difficult question to answer and one that we can't do justice to in an article on class action law reform. For present purposes, it's enough to say that the continuous disclosure provisions require a listed entity to notify investors of information that:
- must be disclosed under the ASX's listing rules;
- is "not generally available"; and
- "is information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of" the securities of the relevant entity.
What's continuous disclosure got to do with litigation funding and the class action industry?
You might be wondering why a parliamentary inquiry into litigation funding and the class action industry is addressing continuous disclosure. That's a good question. Continuous disclosure wasn't a topic that the Parliamentary Inquiry was specifically asked to investigate in its terms of reference. There are three reasons why it dealt with the topic.
First, the prevalence of shareholder class actions has drawn attention to the continuous disclosure provisions. It is common for shareholder class actions to involve alleged breaches of the continuous disclosure provisions. They often include alleged breaches of the prohibition on misleading or deceptive conduct as well. Without boring you with the statistics (and there are plenty), we'll just say that a significant portion of class actions commenced in the last 10 years have been shareholder class actions. Some commentators have said the large number of shareholder class actions is a problem and that this large number is due to the continuous disclosure laws being too demanding of listed entities.
Second, the Australian Law Reform Commission recommended that reform to the continuous disclosure laws be considered. In 2018, the Australian Law Reform Commission conducted an inquiry into class actions and third-party litigation funding which culminated in Report 134, Integrity, Fairness and Efficiency—An Inquiry into Class Action Proceedings and Third-Party Litigation Funders. Recommendation 24 of this report was that the Commonwealth commission a review of the legal and economic impact of the operation, enforcement, and effects of the continuous disclosure laws and the misleading or deceptive conduct laws.
Third, temporary changes were made to the continuous disclosure laws during the COVID-19 pandemic to address some of the (perceived or actual) problems with these laws.
These three matters all put continuous disclosure on the agenda for the Parliamentary Inquiry. The third matter is particularly significant because it became the basis for one of the Parliamentary Inquiry's recommendations. Let's look at it in more detail.
The temporary changes to continuous disclosure laws during the COVID-19 pandemic
On 25 May 2020, the Federal Treasurer made a determination under s 1362A of the Corporations Act which temporarily altered the continuous disclosure laws. The determination applied from 26 May to 26 September 2020 but was effectively extended until 23 March 2021 by a further determination made on 22 September 2020. The temporary changes made by the determinations have now come to an end.
The aim of the two determinations was to introduce a fault element to the continuous disclosure laws. As noted above, the continuous disclosure laws require information to be disclosed to investors if it "is information that a reasonable person would expect… to have a material effect on the price or value of" the securities of the relevant entity. If a listed entity does not disclose such information, it will be in breach of the continuous disclosure laws, provided the information must also be disclosed under the ASX's listing rules and is not generally available. The determinations changed this rule so that an entity will only breach the continuous disclosure laws if it "knows or is reckless or negligent with respect to whether information would have a material effect on the price or value of" securities of the relevant entity. This introduced a fault element by requiring the listed entity to know the information is material to the price or value of its securities or at least be reckless or negligent in not knowing this.
The determinations did not alter the prohibition on misleading or deceptive conduct so as to introduce an equivalent fault element. This was significant because shareholder class actions typically have twin causes of action: one for breach of the continuous disclosure laws and one for breach of the prohibition on misleading or deceptive conduct. Both causes of action are usually based on the same material facts.
A breach of the continuous disclosure laws can result in ASIC civil penalty proceedings, ASIC infringements notices, the commission of an offence under section 1311 of the Corporations Act as well as shareholder class actions. The determinations altered the laws for all four of these.
When the first determination was made, the Federal Treasurer said the temporary amendments will achieve two goals.
First, the temporary amendments will enable listed entities "to more confidently provide guidance to the market during the Coronavirus crisis". This was said to address the risk of them "hold[ing] back from making forecasts of future earnings or other forward-looking estimates, limiting the amount of information available to investors".
Second, the temporary amendments will protect listed entities from "the threat of opportunistic class actions". In support of this point, the Federal Treasurer said the temporary amendments "will make it harder to bring … [shareholder class] actions against companies and officers during the Coronavirus crisis".
While these goals may be laudable and it is difficult to cavil with any amendments that relax the already onerous burdens on boards, there is no empirical evidence as to whether the temporary changes have helped achieve the stated goals. This is especially so when, as already noted, the temporary changes did not go as far as they might because they did not alter the prohibition on misleading or deceptive conduct, which deems a representation about a future matter to be misleading or deceptive if the representation does not have reasonable grounds.
What did the Parliamentary Inquiry recommend?
The Parliamentary Inquiry recommended that the temporary amendments to the continuous disclosure laws be made permanent. It gave the following reasons for this.
- "[S]hareholder class actions are generally economically inefficient and not in the public interest".
- "Shareholder class actions appear to often generate excessive profits for litigation funders and lawyers at the expense of listed companies and their shareholders".
- The costs of defending shareholder class actions are ultimately borne by shareholders. "While some individual shareholders may gain, overall shareholders are losing money, particularly long-term or passive investors".
- Shareholder class actions "provide limited deterrence for corporate misconduct, because those responsible for continuous disclosure breaches do not receive timely sanctions or bear the full costs of their actions".
- The "increasing prevalence of shareholder class actions has broader undesirable outcomes on the availability and cost of D&O insurance with consequential challenges for attracting and retaining experienced and high quality directors and officers".
- "A culture of risk-averse decision-making across Australian boards is a further adverse outcome of shareholder class actions with harmful long-term impacts on economic growth, job creation and investor' returns on equity".
- "The COVID-19 amendments align the requirement to prove fault for continuous disclosure breaches in Australia with requirements in other jurisdictions, such as the US and UK. Raising the bar in this manner makes it much more difficult to bring a shareholder class action".
What are the latest proposed changes?
As mentioned above, the Federal Treasurer announced on 17 February 2021 that the recommendation of the Parliamentary Inquiry to make the temporary changes to continuous disclosure laws permanent will be implemented. So far, this is the only recommendation of the Parliamentary Inquiry that has been implemented. The Commonwealth Government is not proposing to make the precise temporary changes permanent. Instead, it is proposing to alter them while maintaining their primary purpose, which was to introduce a fault element. The proposed permanent changes can be summarised as follows.
- A fault element of knowledge, recklessness or negligence will be introduced to the laws of continuous disclosure. This fault element must be proven (i) to obtain compensation in a shareholder class action or (ii) to impose a civil penalty on the entity or one of its director for involvement in a continuous disclosure breach.
- The same fault element will apply to the laws of misleading or deceptive conduct, as they exist in the Corporations Act and ASIC Act, but only so far as those laws apply in parallel to the continuous disclosure laws. This is an important difference between the temporary changes to the continuous disclosure laws for COVID-19 and the proposed permanent changes.
- However, the fault element will not need to be proven for ASIC to issue an infringement notice or to establish an offence under section 1311 of the Corporations Act. This is significant since if it is established that a body corporate committed an offence for a contravention of the continuous disclosure laws, the maximum penalty is currently $1,332,000. That is a large amount but much less than the maximum penalty that can be ordered against a body corporate under section 1317G for the contravention of a civil penalty provision. An order under section 1317G will require the new fault element.
The proposed changes maintain the integrity of the principles of continuous disclosure to the market which underlie Listing Rule 3.1 and section 674 of the Corporations Act but provide relief for potential civil liability attaching to the companies and officers as outlined above.
The stated rationale for the permanent amendments was to reduce the amount of time and money spent on continuous disclosure compliance and to reduce the amount spent on D&O insurance. These savings of time and money will supposedly arise because listed entities will "not face the same level of financial risk where they allegedly fail to comply with the continuous disclosure rules". It is questionable whether these changes will reduce the amount of time spent on continuous disclosure compliance since the current laws (ie. no fault element) will still apply in respect of ASIC infringement notices and offences. As for a reduction in D&O insurance, that will depend on whether the proposed changes have an effect on the prevalence of shareholder class actions or at least the perceived prevalence. The proposed changes will increase the difficulty of bringing shareholder class actions because they will introduce an additional hurdle that claimants must overcome, but it is too soon to tell whether this will have an impact on the prevalence of shareholder class actions.