Supreme Court Rules on Allegedly Misleading Feltex Prospectus
Houghton v Saunders & Ors  NZSC 74
In May 2004, Feltex Carpets Ltd (Feltex) issued a combined investment statement and prospectus (collectively, the Prospectus) in support of an initial public offer for the sale of shares (IPO). By December 2006, however, Feltex was placed into liquidation. As Dobson J aptly put it at the High Court:
Given the relatively rapid transformation of fortunes, it is unsurprising at an intuitive level that shareholders who purchased shares in the IPO would protest that the business must have been oversold in the prospectus, and that they had not been warned adequately of losing their investment.
Proceedings were filed in the High Court by Mr Houghton against the Feltex directors, Credit Suisse (the private equity vendor of the shares), and the joint lead managers (JLMs) – First NZ Capital and Forsyth Barr. Mr Houghton alleged, in his own capacity and for approximately 3,600 other shareholders that the Prospectus was misleading in several respects under the Securities Act 1978 (the Act) and the Fair Trading Act 1986. Mr Houghton was unsuccessful in both the High Court and Court of Appeal. In September 2017, Mr Houghton’s appeal to the Supreme Court was heard. The Supreme Court issued its judgment on 15 August 2018 – dismissing the appeal in its entirety in favour of the First NZ Capital and Forsyth Barr, but allowing the appeal against the Feltex directors and Credit Suisse.
Fee Langstone acted for First NZ Capital throughout the proceedings and appeals.
Was the Prospectus Misleading?
At the time the Prospectus was prepared, the legislation governing the offering of securities to the public was the Act. Mr Houghton’s claim was based largely on section 56 of the Act, which imposed liability on certain entities to compensate those who purchase securities “on the faith of” a prospectus containing an “untrue statement”. The latter term was defined in section 55 to include statements (or omissions) that are “misleading” in the context in which they are included, with an exception in section 56 removing liability for any untrue statement that the person who included it believed, or had reasonable grounds to believe, was true (referred to as the “due diligence defence”).
There was some disagreement between the different courts as to the threshold test imposed by these provisions. The High Court found that there could be no liability under section 56 unless the statement was misleading in a “material respect”. In other words, it had to be something that “materially contributed to a claimant’s decision to invest.” The Court of Appeal, along similar lines, found that a claimant had to show that reliance was placed on the untrue statement before they could establish that it caused them to suffer loss.
The Supreme Court found, on the other hand, that an investor could prove that they relied on an untrue statement without even having read the Prospectus, an approach the Court felt was reflective of the Act’s objective of investor protection. The Court reasoned that, as a practical matter, investors’ decisions are often made through intermediaries, like brokers, and they “rely on the accuracy of the prospectus in the sense that they assume it contains no untrue statements and that the advice they receive or the market commentary they observe is founded on accurate and complete disclosure” of the information therein.
On this analysis, the Court found that there was one “untrue statement” in the Prospectus. It found that the revenue forecast for FY04 was an “untrue statement” because, at the time of the allotment of shares, the Feltex directors knew that the forecast would not be achieved as there was a shortfall of between $7.5 and $9 million. The Court of Appeal did not consider that the “notional investor” would regard the shortfall as material, and would likely have proceeded even had it been disclosed. The “only question”, according to the Supreme Court, however, was whether the forecast was “untrue, false or misleading.” On the totality of evidence, it held that it was, as the directors knew that the FY04 revenue forecast was not the most probable outcome. It was irrelevant whether the shortfall was “material”; the only consideration was whether the statement was untrue. Being untrue, the statement was therefore capable of causing loss. Consequently, the Supreme Court found that the due diligence defence was not available to the respondents (agreeing with the Court of Appeal). The Supreme Court also found that the statement was misleading under section 9 of the Fair Trading Act. However, the question of what loss (if any) was suffered by the shareholders will be a matter to be considered in a separate stage 2 High Court trial. Issues of causation and loss under the Fair Trading Act will also be determined at the stage 2 trial.
Liability of “Promoters” Under the Act
A fundamental issue in the claim against First NZ Capital and Forsyth Barr was whether, under the Act, they were “promoters” as section 56 extended liability to “every promoter of the securities”, defined as “a person who is instrumental in the formulation of a plan or programme pursuant to which the securities are offered to the public.” The definition of “promoter”, however, expressly excluded “a person acting solely in his or her professional capacity”.
First NZ Capital and Forsyth Bar acted as the joint lead managers on the IPO, advising on regulatory requirements, the content and structure of the Prospectus and offering itself, and the due diligence process.
The High Court held that they did not satisfy the definition of “promoters” under the Act, as they lacked the requisite “instrumentality” without sufficient control and decision-making power over the offer. The Court of Appeal found there was a lower threshold for being “instrumental” than the High Court, which felt that a “promoter” simply needed to take “an active part in forming the plan pursuant to which the shares are offered to the public”, and that a decision-making role was not strictly necessary. It found that the JLMs were sufficiently involved in the IPO to fit this definition.
At the Supreme Court, the JLMs argued that the Act and the authorities indicated that “promoters” needed to have a role in the initial procurement of the offer, and a degree of decision-making power and control such that it was appropriate to impose similar obligations on them to those of the directors. The Court accepted this argument, and while it acknowledged the JLMs were instrumental to the IPO, they were fundamentally acting in a professional and ultimately advisory character and therefore fell within the exclusion.
The Supreme Court restored the High Court’s finding on the issue, and the JLMs were able to completely resist liability. The Supreme Court also found that the JLMs were not in breach of the Fair Trading Act as Mr Houghton failed to prove that the untrue statement in the revenue forecast could not be attributed to them as primary parties.
Comment - Russell Stewart
The claim was brought under the Securities Act, but this has been repealed and replaced by the Financial Markets Conduct Act 2013 (FMCA). Russell Stewart, Senior Associate at Fee Langstone, says that there will be a question as to the extent of the precedential value of the decision – especially as the FMCA does not contain an equivalent definition of “promoter”. However, one thing is clear: those people contemplating directorships should be wary of the “never ending saga” of litigation – the IPO was in 2004; proceedings were commenced in 2008; the final appeal was determined in 2018 and the matter has now been sent back to the High Court for a stage 2 trial.