Lessons from the Lombard Appeal case

For those seeking investment from members of the public to raise capital for their business, a registered prospectus and investment statement is a statutory requirement under Securities Act 1978 ("the Act") for businesses to provide investors with before investors make any capital contributions to a person's business.

The prescribed form and content of a prospectus and investment statement ("offer documents") required to be provided to investors is set out in the Securities Act 1978 ("the Act") and the Securities Regulations 2009. Under the section 58 of the Act, it is a criminal offence for a director to distribute an advertisement (which includes an investment statement) or a registered prospectus with an untrue statement. The offence under section 58 of the Act is of strict liability. Therefore, there is no requirement for the Crown to prove that the accused knew that a statement was untrue.

An untrue statement is defined under section 55 of the Act as follows:

"A statement included in an advertisement or registered prospectus is deemed to be untrue if-

                      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."

Further, section 34 (1) (b) of the Act provides that "no registered prospectus can be distributed if it is false or misleading… by reason of failing, to refer, or give proper emphasis, to adverse circumstances…"

A recent example of criminal offences under the Act is the High Court decision ofR v Graham[2012] NZHC 265 ("the Lombard decision"). The case held that directors may be liable if offer documents contain material omissions. Thus, the sentences of the Lombard directors arose from an amended prospectus which did not express the company's worsening liquidity issues.

InJeffries, Reeves, Graham & Bryant v R[2013] NZCA 188 ("the Lombard appeal") the Lombard directors and the Crown appealed the High Court decision in respect of the sentence the directors received under the High Court decision. In the Lombard appeal, the Court clarified that the statutory obligation not to make untrue statements within an offer document overrides the duty director to act in the best interests of the company (where those duties may conflict).

The Court held that if directors cannot be satisfied that the statements contained in an offer document are true and are not misleading by omission, the offer should not be made irrespective of the consequences that might then flow. Therefore, if in doubt, don't make the offer. Further, it is not enough to simply identify potential risks in a prospectus. A prospectus is required to "bring home the imminence" of those risks. 

The obligations of directors in relation to the accuracy of offer documents not to make untrue statements are non-delegable and cannot be avoided by reliance on information supplied by management.  While directors are entitled to delegate management responsibilities to company's executives, except the accuracy of offer documents, they are for example "obliged to take a more direct personal interest in the company affairs than might have been the case in a more favourable market", such as where there is an "obvious lack of reliability in the critical cash flow projections" of the company.

The Financial Markets Conduct Bill ("the Bill"), which will rewrite the Act, changes the criminal liability test for prosecuting directors in relation to making false or misleading statements or omissions to include the element of a "guilty mind". As a result, under the proposed regime a director would be liable only if he or she knew of, or was reckless as to whether there was a defect in an offer document. The proposed change is distinct from the strict liability test under section 58 of the Act, which should allow directors to be able to focus mainly on business strategy and supervising management, rather than on compliance and liability.

The Bill is a major over haul of the securities law in New Zealand. When the Bill comes into force people will probably first notice the changed format of the prescribed form and content of offer documents. The Lombard directors are taking their case to the Supreme Court. We will be following its decision in due course.