29 Jan 2008

Compliance with continuous disclosure obligations

by Greg Seeto, Graeme Howatson

An effective continuous disclosure compliance program is essential if a company and its directors are to avoid breaching the Corporations Act 2001.

Complying with continuous disclosure obligations is vital for every Australian Stock Exchange listed company. On top of being a legal requirement, having in place an adequate compliance system is an important factor in helping raise a defence for persons involved in an alleged contravention of continuous disclosure obligations.

Section 674(2B) of the Corporations Act 2001 provides that the due diligence defence may be successfully raised when a person involved in the alleged contravention proves that they took all reasonable steps to ensure that the company complied with its disclosure obligations, and, after doing so, believed on reasonable grounds that the company had complied with those obligations.

Having a robust compliance system will help show that all reasonable precautions had been taken by putting in place procedures to avoid any potential breaches of the continuous disclosure requirements.

Continuous disclosure - what does the Act require?

In summary, an entity's continuous disclosure obligation is set out in section 674(2) of the Act. Section 674(2) states that a listed disclosing entity must notify the market operator (eg. the ASX) of information that:

1. is required to be notified to the market operator (eg. the ASX); and

2. that information:

(a) is not generally available; and

(b) is information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of Enhanced Disclosures securities ("ED securities") of the entity.

Section 674(2A) states that a person who is involved in a listed disclosing entity's contravention of the entity's continuous disclosure also contravenes the Act.

A person is involved in a contravention if they have aided, abetted, counselled, procured or have been knowingly concerned in the contravention (section 79).

An entity is a "listed disclosing entity if all or any ED securities of the entity are quoted ED securities" (section 111AL).

Section 111AE defines "ED securities" as securities issued by a body corporate which:

  • with its agreement, consent or acquiescence, is included in the official list of a prescribed financial market (eg. the entity is listed on the ASX); and
  • the market's listing rules (eg. the ASX Listing Rules) apply to the body in relation to a class of securities issued by the body.

ASX Listing Rule 3.1 requires an entity once it is, or becomes aware of, any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, to immediately tell the ASX that information.

An entity is "aware" of information if:

"… a director or executive officer … has, or ought reasonably to have, come into possession of the information in the course of the performance of their duties as a director or executive officer of that entity." (Listing Rule 19.12)

An "executive officer" is a person concerned in, or taking part in, the management of the entity.

The inclusion of the words "ought reasonably to have" in the listing rule means a company needs to have a system for ensuring that information requiring disclosure is identified and communicated to the person who has the authority to disclose it to the ASX.

Exceptions to Rule 3.1 are found in Rule 3.1A. The ASX's interpretation of Listing Rule 3.1 is set out in ASX Guidance Note 8, Continuous Disclosure: Listing Rule 3.1 ("GN 8"). The Attachment to GN 8 gives some examples of situations where disclosure will or will not be required.

Listing Rule 19(2) is also relevant to the interpretation of Rule 3.1. It requires an entity to comply with the listing rules in accordance with their spirit and in a way that best promotes the principles on which the listing rules are based.

Failure to comply with section 674(2) may give rise to prosecution for an offence, civil penalty proceedings or the issuing of an infringement notice by Australian Securities and Investments Commission. A person involved it he contravention of an entity's continuous disclosure obligations (ie. breach of section 674(2A)) may be liable for civil, but not a criminal penalties.

However, as mentioned above, section 674(2B) of the Act sets out a due diligence defence pertaining to breaches of section 274(2A) (ie. persons involved in the contravention of a continuous disclosure obligation). Section 674(2B) states:

"A person does not contravene subsection (2A) if the person proves that they:

(a) took all steps (if any) that were reasonable in the circumstances to ensure that the listed disclosing entity complied with its obligations under subsection (2); and

(b) after doing so, believe on reasonable grounds that the listed disclosing entity was complying with its obligations under that subsection".

Complying with section 674 - what is required?

As Justice French observed in Australian Securities and Investments Commission, in the matter of Chemeq Limited (ACN 009 135 264) v Chemeq Limited (ACN 009 135 264) [2006] FCA 936, meeting the requirement for continuous disclosure may be difficult to achieve because it "… is a positive obligation that is not related to any particular [business] decision."

So what then is required to achieve compliance? Based on Justice French's judgment in Chemeq, GN 8 and the requirements of Australian Standard 3806-2006, a continuous disclosure compliance program should include:

  • A continuous disclosure policy approved and issued by the entity's board. In the light of Listing Rule 19.2, where there is any doubt, the entity's policy should be to require disclosure.
  • The nomination of a senior officer (such as the company secretary or compliance manager) to be responsible for continuous disclosure (GN 8; Chemeq). One of the first functions of the officer on appointment should be to oversee an assessment by each business unit of the company to determine the areas where issues that need to be reported are likely to arise.
  • Written operating procedures (approved by the board or board subcommittee) which deal with how matters that may give rise to a continuous disclosure obligation are to be identified, and, once identified, set out all necessary steps which must be taken in discharging the obligation. The procedures should also:
    • deal with how to respond to market rumours, leaks and inadvertent disclosures (GN 8; Chemeq); and
    • provide for the review of briefings and discussions with analysts or the media to check that price sensitive information will not be, or has not been, disclosed (GN 8; Chemeq).
  • Inclusion of information about the entity's continuous disclosure policy and operating procedures in induction training given to directors and senior management.
  • Provision for follow up and refresher training as required.
  • Monitoring to ensure that the company is discharging its continuous disclosure obligations and the reporting of the results of such monitoring.
  • Breach reporting, rectification and disciplinary measures to be taken against persons who do not comply with the company's continuous disclosure policy and/or operating procedures.
  • The review of the policy and operating procedures as required.

A recent development - claims for damages by shareholders

Riley (in his capacity as trustee of the Ker Trust) v Jubilee Mines NL [2006] WASC 199

Riley was the first case in which a court awarded a shareholder damages for a breach by a company of its continuous disclosure requirements.

In Riley, the Court held that Jubilee Mines had been negligent in releasing drilling results to the market two years after the company had received them. The Court found that if the information had been released when the company received it (as required by the continuous disclosure rule), the plaintiff would have retained the company's shares for a longer period and subsequently sold them at a higher price. Riley was awarded damages of approximately $1.8 million, which was the Court's assessment of the loss suffered as a result of the "early" sale.

Perhaps of greater concern for companies, however, has been the recent commencement of a number of multi-million dollar class actions for breach of continuous disclosure requirements.

Class actions - Aristocrat Leisure Limited

Stage one of the hearing of the Aristocrat Leisure Limited class action concluded in the Federal Court of Australia on 30 October 2007.

The action is on behalf of all shareholders who acquired shares in Aristocrat Leisure Limited between 19 February 2002 and 27 May 2003 and who suffered loss as a result of Aristocrat allegedly overstating its profits and failing to disclose that it would not meet its earnings forecasts. The claims of known class members total in excess of $200 million. Judgment in relation to stage one of the litigation is expected in early 2008.

Class actions - Taylor v Telstra Corporation Ltd [2007] FCA 2008

On 13 December 2007, the Federal Court of Australia approved a settlement under which Telstra agreed to pay up to $5 million to shareholders for allegedly failing to disclose to the market information from a briefing that Telstra had given to the Federal Government.

Class actions - Campbell Cash and Carry Pty Limited v Fostif Pty Limited [2006] HCA 41

In 2006 the High Court in Campbell made it clear that, in the Federal and some State jurisdictions, there is no legal impediment to litigation funding companies funding legal action in return for a proportion of the damages recovered by the action. A consequence of this decision is likely to be an increase in the number of class actions for failing to make disclosures to the market.

Directors' due diligence defence

The due diligence defence was inserted into the Act by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 ("CLERP 9 Act"). The due diligence defence has not yet been tested before a court, but the supplementary explanatory memorandum to the CLERP 9 Act gives some guidance in relation to its likely operation.

Paragraph 4.83 notes that "reasonable steps" "encompasses the assessment whether particular information is required to be disclosed and the process for disclosing it."

Paragraphs 4.84 and 4.87 state:

"The notion of reasonable steps is obviously for the court to decide on the facts of a particular case and may include, in appropriate circumstances, instances of delegation and reliance on others.

The defence does not address situations where, for example, the view of a compliance officer, individual board member or secretary is overruled, with the result that the disclosing entity has contravened its continuous disclosure obligations. This is not addressed because such a person would not be "involved in" the contravention in the sense required by section 79 of the Corporations Act 2001."

Based on the information in the explanatory memorandum, it seems that an effective compliance program will be required if a director is to be able to rely on the due diligence defence.

The original CLERP 9 explanatory memorandum discusses what is required in order for a director to be "involved in" a contravention of the continuous disclosure requirements:

"Involvement in a contravention … requires some form of intentional participation and actual knowledge of the essential elements of the contravention."

Conclusion

Since mid-2004, when ASIC's power to issue infringement notices for breaches of the continuous disclosure requirements commenced, there has been a greater focus by the regulator on breaches of the continuous disclosure requirements.

Meeting the continuous disclosure requirements of the Act is an ongoing task and as the Chemeq case observes, may be difficult to achieve.

By virtue of section 674(2A), an entity's breach of its continuous disclose obligations not only opens it up for prosecutions, civil penalties and infringement notices from ASIC, persons involve in the contravention may also be liable. Accordingly, an effective continuous disclosure compliance program is essential if a company and its directors are to avoid breaching its continuous disclosure obligations and establishing a due diligence defence.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.