«Elizabeth Joan Painter A dissertation submitted in partial fulfilment of the degree of Bachelor of Laws (Honours) at the University of Otago, ...»
Section 496: A New Era in Civil Liability for Misstatements?
Elizabeth Joan Painter
A dissertation submitted in partial fulfilment of the degree of Bachelor of Laws (Honours)
at the University of Otago, Dunedin, New Zealand
10th October 2014
First and foremost to my supervisor Associate Professor Shelley Griffiths for her
guidance, encouragement and time. I am grateful to have had such a committed
supervisor to keep me on track.
To my family for all of the love and support they give me in everything I do.
And to my friends for making my five years at University incredible.
Table of Contents I. Introduction 5 II. New Zealand Securities Law – Past and Present 6 A. Securities Act 1978 6
1. Why did the Securities Act Come About? 6
2. Overview of Securities Act 1978 Liability Provisions 7
a) Section 55(a) 7
b) Section 55G 8
c) Section 58 10
d) Lombard Case Scenario 10 B. Financial Markets Conduct Act 2013 13
1. Overview 13
2. Why Did the FMCA Come About 14
3. Civil Liability Under the FMCA 15
4. Policy Behind Section 496 Financial Markets Conduct Act 17 III. Financial Theory and Section 496 21 A. Financial Theory 21
1. Efficient Markets Hypothesis 21
2. Fraud on the Market 21
3. Where it all Began – Basic v Levinson 23 B. Financial Markets Conduct Act 2013 24
1. Section 496 24
2. How Does The Financial Theory Fit With Section 496? 25
3. Is There a More Suitable Alternative? 27
4. Measuring Loss in New Zealand 28 IV. Comparison to the United States, Australia and Canada 31 A. United States of America 31
1. Legal Tests 31
The Financial Markets Conduct Act (FMCA) came into force on 13 September 2013.
The FMCA replaced several Acts, most notably in this context the Securities Act 1978 (SA). The SA was New Zealand’s first attempt at a complete regime governing the primary securities market. However throughout the duration of the SA significant gaps in the liability regime came to light; firstly in the stock market crash of 1987 and more so in the wake of the financial crisis of the 2000s. The FMCA is the result of these events and also of various recommendations for reform. Comprehensively updating an area of law like this comes once in a generation. As such, the process of reform was long and extensive consultation was sought.
One of the significant changes in the FMCA is the civil liability regime for “defective disclosure” in offer documents.1 Compensation for misstatement was ineffective under the SA. Accordingly, improving this was a primary focus when legislating the new Act.
In a fundamental change from the civil liability provisions of the SA, s 496 FMCA introduces a rebuttable presumption of loss for defective disclosure. It is likely this will significantly change the structure of liability for issuers, with more exposure to civil liability and criminal liability left to the most serious violations of the FMCA. The theory underlying s 496 and the impact the new scheme is expected to have on securities law in New Zealand is the focus of this dissertation. Section 496 can be found in the appendix.
Chapter II discusses New Zealand’s security law as it was under the SA and looks at the new regime for civil liability under s 496 FMCA. Chapter III then considers the financial theory that underlies the new civil liability provision. Following this, the methods employed in the United States, Australia and Canada are compared in Chapter IV. Finally, Chapter V looks at how the new section will be applied, and how successful it is likely to be as compared to the SA.
This chapter provides a brief recent history of New Zealand securities law to give the issues context and to understand the fundamental change in our regime. It includes analysis of the key liability sections in the SA and how they operated. Also considered is the new FMCA, in particular civil liability under s 496, why the FMCA came about, and the policy underlying it. If the aim of the FMCA is achieved, the two Acts will have opposite liability regimes; the SA employing criminal liability as the main route of enforcement, and the FMCA making civil liability the primary method of enforcement – leaving criminal sanction to the most egregious of cases.
A. Securities Act 1978
The SA was the first Act in New Zealand to incorporate securities law into one piece of legislation. Prior to this the Companies Act 1955 governed some parts of securities law such as issuing prospectuses, but lacked specific provisions.2 New Zealand was thus in need of some substantial securities laws. Subsequently, the SA came into force controlling fund raising and also providing for the establishment of the Securities Commission. The Securities Commission was the regulatory body responsible for overseeing the securities markets, which was replaced by the Financial Markets Authority (FMA) in 2011.
1. Why Did the Securities Act Come About?
“Nothing important might happen except in crisis”.3 This was a primary reason for the development of the SA, with the collapse of major companies such as Securitibank in the 1970s. Before the SA, companies were acquiring funds from the public in such a way that they could avoid the existing protection that was provided for the investing public. 4 The government accepted that “activity based” legislation was required, applying to everyone involved in the activity of raising money from the public and stepping away from the previous “entity based” legislation.5 Behind the SA was the idea that failure in the market can be improved by government intervention or regulation – the “market failure” theory of regulation.6 Accordingly, after Peter Fitzsimons “New Zealand Securities Commission: The Rise and Fall of a Law Reform Body” (1994) 2 WLR 87 at 89.
Mark Roe “Chaos and Evolution in Law and Economics” (1996) 109 Harv. L. Rev. 641 at 663.
Fitzsimons, above n 2, at 89.
Gordon Walker “Chaos and Evolution in New Zealand Securities Legislation” (1997) 9 Otago L. Rev. 14 at 44.
Fitzsimons, above n 2, at 90.
the collapse of these companies the government responded to control fund raising from the public with the main purpose being investor protection.7 However, this came with the proviso that companies should not have to deal with inflexible regulation.8 Well before the development of the SA, the Barton Report noted in 1934 that corporate abuse would affect New Zealand’s reputation and ability to attract potential investment.9 This is an issue that still underlies securities regulation, with investor confidence in the market being of primary importance. Despite this early insight, none of the recommended reforms in the Barton Report were implemented in the subsequent legislation, which instead focused on specific companies.10 Over 40 years later, the SA reflected some of the reforms anticipated in the report.
2. Overview of Securities Act 1978 Liability Provisions
Under the 1978 Act, criminal and civil proceedings could be brought for misstatements in advertisements or registered prospectuses under ss 55 to 60 SA. Under s 2A(2)(b) SA an “investment statement” is included within the meaning of advertisement. The investment statement is aimed at the “prudent but non-expert person” pursuant to s 38D and must advise investors that there is further information available in the registered prospectus. Accordingly, “the person reading the prospectus should be treated as the same ‘prudent but non-expert person’ to whom the investment statement is directed.”11
An untrue statement was required for liability for misstatements in advertisements or registered prospectuses under both the civil and criminal provisions of the SA.12 “Material” was not defined in the SA, though it was an important filter in determining the relevance of information. New Zealand adopted the American interpretation of Fitzsimons, above n 2, at 90.
Fitzsimons, above n 2, at 90.
Walker, above n 5, at 38.
Walker, above n 5, at 39.
R v Moses HC Auckland CRI-2009-004-1388, 8 July 2011 at .
Securities Act 1978, ss 55G and 58.
materiality that was expounded in TSC Industries Inc. v Northway Inc in the case of Coleman v Myers.13 Although Coleman does not consider the SA, it has been accepted as adopting a relevant definition of materiality for the SA.14 The case was regarding directors’ duties and whether information that the director had but the shareholder did not have was material. Accordingly the case concerned disclosure and developed a test appropriate for the SA. The materiality standard involves considering whether “there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”15 Heath J stated in R v Moses, a case regarding criminal liability under the SA, that the concept of materiality in regards to omitted facts should not be defined “too tightly”; if there was something that should have been disclosed and would likely have made a difference to the decision whether to invest, it would almost certainly be considered material.16 Moses also indicated that whether a statement is misleading must be judged contextually, not literally.17 Deciding if the document contains an affirmative statement that is “untrue” is an objective inquiry and is to be viewed through the eyes of a “prudent but non-expert person”, or the “notional investor”.18 Heath J summarized the notional investor in Moses as: somewhere between completely risk averse and someone prepared to take a high level of risk; sufficiently intelligent and literate with a general understanding of technical words; would seek assistance from a financial adviser and comprehend competent advice; and of modest financial means, neither rich nor poor.19
Investing “on the faith of” an advertisement or registered prospectus thus requires investors to prove reliance. In an early interlocutory appeal for Saunders v Houghton the TSC Industries Inc v Northway Inc 426 US 438 (1976); Coleman v Myers  2 NZLR 225 (CA).
John Farrar and Susan Watson (eds) Company and Securities Law in New Zealand (2nd ed, Brookers, Wellington 2013) at [34.4.3(2)(a)].
TSC Industries Inc v Northway Inc, above n 14, at 449.
R v Moses, above n 11, at .
Court of Appeal appeared attracted to the idea that reliance on the fact of the prospectus was enough. 21 In particular, this was because shareholders were able to invest on the investment statement alone without receiving the prospectus.22 Moreover, the Court recognised that indirect reliance was possible where the prospectus forms the basis of advice from a broker or a news report.23 This idea was supported in the recent Houghton v Saunders decision from the High Court, where Dobson J noted that “on the faith of” connotes a “less direct connection than reliance on specific aspects of misleading content or omission.”24 Despite allowing this “less direct connection”, establishing reliance was nonetheless a tough hurdle for investors to prove. Additionally, cases were even more difficult because each investor arguably had to establish reliance individually.25 This made the use of representative actions problematic in New Zealand; in reality this kind of “class” action option was almost impossible. However, the cost of bringing an action individually would generally outweigh the potential gain for most investors.
Section 55G also requires investors to show causation. The phrase “by reason of the untrue statement” necessitates that the untrue statement caused the loss or damage suffered by the plaintiff. Likewise, establishing this element was a significant challenge for investors, particularly when the idea of intervening causes come into play. For example, many of the recent cases under the SA were the result of finance companies collapsing in the wake of the Global Financial Crisis (GFC). Consequently, investors faced difficulties in claiming that the statement caused the loss when negative effects of the GFC were still being felt.
Plaintiffs therefore had to establish the elements of reliance, causation and, in the case of omissions, materiality, before they could gain compensation under the civil liability provisions. This proved almost impossible with the first case on s 55G, Houghton v Saunders, being decided only recently after the FMCA had already replaced the SA.26 Section 55B was introduced in 2006 and provides that a “civil liability event” is “a distribution of an advertisement or a registered prospectus that includes an untrue statement”. 27 The purpose of this concept was “to enable a person who brings proceedings under section 55G to rely on the declaration in the proceedings for Saunders v Houghton  3 NZLR 331; (2009) 20 PRNZ 215 (CA) at  and .
Houghton v Saunders  NZHC 2229 [15 September 2014] at .
See Houghton v Saunders,  NZHC 1828;  NZCCLR 31 at  where the scope of reliance and whether it was an individual or common issue was discussed.
Above n 24.
compensation, and not be required to prove the civil liability event.”28 A declaration is “conclusive evidence of the matters” stated in it, delivering some help to plaintiffs as they could rely on a civil liability event as established by the Securities Commission (now the FMA) for s 55G.29
Contrasting s 55G, criminal liability under s 58 employed strict liability for
misstatements in an advertisement or registered prospectus. The section states:
Section 58 has consequently seen numerous prosecutions, the strict liability nature of the provision making it significantly easier for cases to be brought against issuers than under the civil provisions (see, for example, R v Moses30 or R v Petricevic31). A defence was provided in subs (2) and (4) of s 58 where the defendant could prove “that the statement was immaterial, or that he or she had reasonable grounds to believe, and did…” believe that the statement was true.