Does Australia need to review its continuous disclosure regime?

Has Australia's continuous disclosure regime reached a tipping point? Quentin Digby, Garth Riddell and Barry Wang from Herbert Smith Freehills argue for a rethink.

Recently, the AICD policy team asked us to undertake a review of international continuous disclosure and liability regimes, which has revealed that Australian listed company boards are faced with higher reputational and personal liability risks from disclosure-based shareholder class actions than boards in the world’s major capital markets, including the UK and US. This is reflected in significant increases in the cost of directors and officers (D&O) liability insurance in light of the proliferation of shareholder class actions in Australia.

Many boards are already grappling with the difficult decision about renewal of D&O insurance at a cost, which is hard to justify, even though few prominent directors would remain willing to serve without having the protection of appropriate insurance.

On the face of it

At first glance, Australia’s continuous disclosure regime may not appear significantly different from most other jurisdictions. Feedback from lawyers in the US, UK, Canada, Hong Kong and South Africa confirms that, at a high level, all listed companies in those jurisdictions are obliged to disclose material information to the stock exchange in a timely manner.

Many of those jurisdictions (but not all) have shareholder class action regimes and directors can be found personally liable for false and misleading statements. Beneath these superficial similarities, there are some fundamental differences that have significant consequences for Australian directors.

Beneath the surface

Australia’s market disclosure regime differs from its peers in three key respects:

1. The continuous disclosure rule has the force of law and can give rise to personal liability for directors without the director engaging in any misleading or culpable conduct
2. There is no “safe harbour” from liability for forward-looking statements in company reports, even when statements are identified as forward-looking based on sound application of business judgement and appropriately qualified
3. Our facilitative class action regime provides an incentive for plaintiff firms to consider initiating class actions (with a view to settlement) whenever a market disclosure is followed by a significant change in the share price.

Force of law

The continuous disclosure rule is set out in the listing rules of the Australian Securities Exchange (ASX). It requires listed entities to continuously disclose materially price-sensitive information to the market, subject to certain exceptions. On its own, the rule creates a sensible and balanced continuous disclosure regime that protects investors and ensures the operation of a fair and informed market. The regulatory burden created by the rule is similar to that imposed by securities exchanges in other comparable jurisdictions.

Market participants and stakeholders — including the AICD — support these principles and recognise the importance of a robust continuous disclosure regime.

However, the Australian regulatory environment includes an additional element beyond that found in major capital markets. The continuous disclosure rule is given the force of law under the Corporations Act 2001 (Cth) and, in conjunction with the civil penalties regime in the Act, provides a right for any person who suffers loss as a result of a contravention to seek compensation from the company and any person involved in the contravention. This is not a feature of the continuous disclosure regime in major comparable jurisdictions.

Forward-looking statements

In Australia, any forward-looking representation to the market is taken to be misleading if the person making the representation does not have reasonable grounds for making the statement. A court may order any person making the statement to pay compensation to any person who suffers damage as a result.

The “deeming” feature in Australian law is combined with the lack of a “safe harbour” defence for forward-looking statements available in other jurisdictions such as the US and Canada. In those jurisdictions, liability can be excluded in some circumstances where the forward-looking statement is identified as such and accompanied by proximate cautionary statements.

While Australian courts have adopted a pragmatic and reasonable approach in determining what constitutes reasonable grounds for a forward-looking statement, it is clear that the Australian Securities and Investments Commission (ASIC) and plaintiff lawyers, with the benefit of 20/20 hindsight, apply an extremely high threshold. Inevitably, a company faced with a claim will look to settle rather than risk an adverse decision, especially when the settlement will curb the cost and management distraction involved in lengthy court proceedings.

Class action risk

It is very difficult (if not impossible) to ensure ongoing comprehensive compliance with Australia’s continuous disclosure regime. This is evidenced by numerous instances where highly regarded and well-managed listed companies have received ASIC infringement notices or been the subject of class action claims.

Australia’s comparatively mature and facilitative class action law creates a constant risk for listed companies that a class action can be brought by plaintiff lawyers representing a class of investors whenever there is a significant movement in the share price following an announcement. The relatively easy allegation is that the class has suffered a loss because the information was not announced sooner.

By way of contrast, in the US and the UK, the link to liability under legislation is more remote, requiring an element of misleading conduct or misbehaviour on the part of the company and its officers. In some of the other smaller jurisdictions, where the legislative framework is closer to the Australian provisions, the disclosure requirements are not linked with class action laws, which facilitate the commencement of class actions on behalf of broad classes of shareholders. For example, Hong Kong doesn’t currently have a class action regime.

What does this all mean?

Australian directors have a unique potential to incur class action liability because they can be held liable through a class action simply because they were involved in a breach of the continuous disclosure regime, without the plaintiffs needing to show any misleading or culpable conduct by the director. This risk is becoming harder to insure against in a cost-effective manner.

Sooner than we think, we could reach a tipping point where it will be too expensive for companies to insure their directors. If the experience of other jurisdictions is anything to go by, legislative change is likely to follow to ensure that the risk of being a director does not disproportionately outweigh the potential rewards. In the US, unsustainable D&O pricing resulted in the law being changed to allow company constitutions to exempt directors from any claim for breach of duty absent gross negligence or wilful misconduct on the part of the director.

If a solution is not found, Australian companies could be disadvantaged in the increasingly global search for director talent. Consideration of potential reforms to address these issues would be timely. The AICD has argued directors should have clearer defences where they have acted reasonably, honestly and taking into account the circumstances facing the corporation with appropriate care and diligence.

The Australian Law Reform Commission (ALRC) reports in December on its Inquiry into Class Action Proceedings and Third-Party Litigation Funders. Hopefully, the final report advocates the government commission a review of the legal and economic impact of continuous disclosure and misleading and deceptive conduct obligations, as per the ALRC proposal.

Shareholders are rarely material beneficiaries of shareholder class actions. Any settlement reached will be reduced by the substantial legal fees involved and, to the extent the settlement funds erode the assets of the company, continuing shareholders will indirectly wear the cost. The cost-benefit equation associated with the current continuous disclosure law needs to be closely re-examined. It is clear that concerns regarding the proliferation of disclosure-based securities actions will increase rather than abate over the coming years, and the rising cost of D&O insurance will bring things to a head.

Quentin Digby, Garth Riddell and Barry Wang are members of the Head Office Advisory Team at Herbert Smith Freehills.