This article was first published on The Australian on the 22nd of February 2019.
It’s the scenario every listed company CEO and CFO fears – an impending earnings downgrade, a contract gone bad, or the first solid indication of a material fraud or mistake. Whatever the cause, the Board will be unhappy, investors will adopt a “sell first, ask questions later” approach, and a raft of journalists, regulators and class action lawyers will carefully parse the company’s statement looking for the “hook” – the makings of a prosecution, a juicy class action or maybe just a good story.
More frequently than ever, that “hook” comes in the form of an apparent or alleged violation of the continuous disclosure obligations under section 674 of the Corporations Act.
The Act effectively incorporates by reference the continuous disclosure obligation under ASX Listing Rule 3.1. That rule is very simple to state in principle but (as evidenced by the 86-page Guidance Note published by ASX on the subject) devilishly hard to apply in practice. In short, subject to limited exceptions, companies subject to the rule need to “immediately” disclose to the market information which would have a material effect on the price or value of securities.
It’s hard enough for boards to assess whether information is “material”, but even if there is little doubt on this point, there is the challenge of responding to the second question routinely put by ASX in its standard “aware letter”, which is; “When did [insert name of hapless listed entity] first become aware of the information”?
While it might be easy for an individual, it is a lot harder for a company - which may have tens of thousands of employees, multiple layers of executive management and literally terabytes of data flowing through its network daily - to answer that question. Identifying the first point of “awareness” can go beyond difficult and enter the realm of the metaphysical.
As any director will tell you, the information a board receives is a mix of continuous and sporadic, objective and subjective, definitive and “fuzzy”. Genuine moments of coherent collective consciousness of the kind the law assume are routine are actually very rare.
Unfortunately, a wrong answer to ASX’s question may lead to serious consequences. ASIC has begun to adopt a more activist approach to enforcement in this area, and is about to be handed a much bigger stick, with maximum penalties for companies set to leap to three times the benefit gained or detriment avoided or 10% of annual turnover (up to a staggering maximum value of $525 million).
These are significant penalties. But can it really be said that a breach of continuous disclosure obligations for a day, a few days or even a few weeks, has a profound effect on market integrity? We are, after all, talking about a largely zero-sum scenario. Late disclosure of bad news harms some shareholders (those that bought in the period after the information should have been announced, but before it was), but benefits others, being those who sold during the same period.
There is enough doubt over this fundamental question for the Australian Law Reform Commission, in its December 2018 Report on Class Action Proceedings and Third Party Litigation Funders, to call on the Government to review the legal and economic impact of the “operation, enforcement and effects” of the continuous disclosure regime. In our view, this is an area in need of reform. We think there are two models that could be considered.
The first, more radical approach, would be to abolish continuous disclosure and replace it with a system of mandatory quarterly reporting coupled with an immediate announcement obligation in relation to pre-defined categories of “significant transactions or events”. This approach would leave the work of routine earnings downgrades to the quarterly cycle.
The second is to create a definitive “reasonable measures” defence for the company and its officers, akin to the due diligence defence in fundraising law. Provided it could be established that the company implemented “reasonable measures” to ensure material information was reported to the market in a timely manner, it would not be punished if on any particularly occasion it failed to do so.
Both approaches have a similar effect of providing companies and Boards with a safe harbour for certain categories of information: one delineated by time, the other by process.
In the post-Hayne environment, it may seem odd to argue for what could be considered a watering down of investor protection. But constantly tightening the screws on directors isn’t without costs either. We need a more nuanced approach to corporate regulation which doesn’t require Boards to constantly live in fear of how minute exercises of judgment on imperfect data will be assessed with the benefit of hindsight.