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Continuous Disclosure Folly

  • February 18th, 2021

In Australia, the government has braved the screeching of the corporate litigation funding jackals, and the chorus of investment organisations who think they currently get a free lunch, to make timid changes to their continuous disclosure regime. It always promised more than it could deliver, and much more than a rational rule would try to deliver.

In New Zealand the NZX worthies have almost simultaneously moved into the exposed, expensive and probably pointless battlements from which Australian companies can now partially withdraw.

The problem was always failure to define the problem before turning a slogan into a rule. NZX has not bothered to define the problem during its 20 years of trying to ape the Australians

Disclosure should have been about making companies minimise the risk that members might trade without information held by their company, with others who did hold it. It would address the unfairness of people being dorked with what should be their own information,  which has been withheld from them but not others. In other words, the rule should have been ancillary to effective insider trading law. Arguably that could usefully extend to protect non-members trading at an unfair information disadvantage with informed members or third parties – so the duty is to the market, not just fairness to existing shareholders.

Instead Australasian continuous disclosure legislates a slogan that ignores the value of company information, or subordinates it to an untested theory that somehow companies will be valued fully only if they can all be expected to continuously spill their guts. It is as if no one knew that proprietary information is commonly among the most valuable of company assets. A sound continuous disclosure obligation should have been ruthlessly enforced against companies that permitted uninformed trading when they knew, or ought to have known that their valuable information was no longer held secure in hands not free to trade.

Nearly two decades ago, as NZX emerged from demutualization, it handed to politicians and officials the control of the Listing Rules that define its product. Since then NZX has not been free to adjust the delicate balance between issuer and investor interests needed to preserve the flow of listings. Among the damaging losses, was the capitulation to those who believed we had to ape Australian regulation. Australia had long had one of the most pretentious continuous disclosure regimes. But as is often the case in Australia, it was ameliorated by tacit consensus that the rules did not really have to mean in practice what they appeared to say.

New Zealanders, however, have been generally less cynical. We want the law to be enforced to mean what it says, even if there is often too little resource applied to that. So when our regime promised we’d have a fully informed market, we wanted it to deliver that, dismissing as unworthy the worries about logic, incentives or practical enforceability (and thus integrity).

The problem is, as it always has been, that “fully informed market”, and “continuous disclosure” are just slogans. For businesses, commonly it is not in the interests of the company or its investors to spill its guts in front of competitors, contract counterparties and others who are not listed here, and therefore able to conduct business in the normal way – that is keeping their strategies, concerns and way stations to themselves. Some of the regulatory exceptions recognize particular circumstances when markets should not be fully informed. They illustrate the illogic of an underlying rule that has not identified its target, or what kind of promise can honestly be held out to investors.

A result of our naive continuous disclosure obligations has been a dearth of companies willing to list, and grave concern about the distractions to boards of worry about their disclosure liabilities, especially in fast growing companies in uncertain new fields.

Rob Cameron warned of this problem when his Task Force reported a decade ago. I was reminded of this by eminent director Dame Alison Paterson when she asked me last year to comment on the problem at one of her retirement functions. We regard it as the biggest unaddressed mistake in our capital markets regulation.

Now the Australian Government is using the Covid crisis as an opportunity to back out of the blind alley it entered more than 30 years ago.  It has confirmed the permanent end to strict liability or non-fault liability for non-disclosure (i.e. irrespective of intention, or knowledge of the fault or even of the information). The new test will be whether the officers concerned have acted with “knowledge, recklessness or negligence”.

This puts the spotlight on last year’s NZX knee jerk reaction to disappointment with the Fletcher board, to highlight an exposure for directors who fail to disclose information that they (or any senior manager) “ought reasonably have come into possession of”.  They blithely dismissed warnings of the exposures that creates, which even the most meticulous directors may have no way to avoid. Who can be reassured by saying it creates incentives to “ensure that issuers have appropriate systems and controls in place so that material information is brought to the attention of senior management efficiently”. The NZ rules will not defend directors who have tried to create that result and failed.

Ah well, at least our late decision to become more Aussie than the Aussies will curry favour with some Aussies. The distraught litigation funders cited in the AFR article of 17 February will be able to deploy some of their newly surplus resources here. They can transfer their strict liability opportunism to naïve Kiwi targets.

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