CBL – accessory liability under the FMC Act

As noted in the media, at the end of February the High Court delivered an important decision, as part of the aftermath of the collapse of the former NZX-listed insurer CBL Corporation.

The decision, finding CBL’s former CFO liable for breaches of the ‘continuous disclosure’ provisions under the FMC Act, is the first time a New Zealand court has considered the question of accessory liability, by a director or officer as an accessory to a company’s breaches of the FMC Act.

Ultimately, at the conclusion of a complex case involving allegations of breaches of both the ‘fair dealing’ provisions in Part 3 of the FMC Act and ‘continuous disclosure’ provisions in part 5, the High Court found that the CFO was involved in three specific breaches of Part 5.  Note that the penalties are to be the subject of a subsequent hearing.

Accessory liability is a bit of a hot button topic overseas, because of a recent UK Supreme Court judgment, considering whether two directors were personally liable under English law as accessories in the infringement of trade marks.

What is apparent is that the question of accessory liability is often very fact specific and will require careful consideration of the particular facts and circumstances in every case.

The CBL backstory

This is the latest judgment in a string of cases stemming from the collapse of CBL.

The fair dealing claims were for misrepresentations to investors.  And the claims based on non-compliance with continuous disclosure obligations related to failures to disclose specific items of material information to the market (via the NZX announcements platform).  In each case, the FMA brought claims against both CBL, and its directors and the CFO.

Importantly, the claims against the directors and the CFO were as ‘accessories’ to the breaches by CBL.

Accessory liability is a matter that frequently arises in New Zealand in the context of public good-type matters, such as breaches of resource management and health and safety matters.  It is sometimes referred to as backstop liability – because it enables claims to be brought against the individuals who were involved in the contravention (by their employer).  One of the lessons from the UK Supreme Court decision mentioned in the introduction is that questions of accessory liability are typically very fact specific and will require careful consideration of the particular facts and circumstances in every case.

Central to the FMA’s case was the question of whether the directors and officers were, directly or indirectly, “knowingly concerned in, or party to”, the breach.

The procedural background to the decision was long and complicated.  CBL had (in earlier proceedings) previously admitted some of the FMA’s causes of action and there had been some settlements secured against the directors, but the admissions from other parties were inadmissible in the case against the CFO. 

This appeared to leave the CFO as the last man standing in a trial that required the FMA to prove the primary breaches (by CBL), which ultimately led to findings in respect of the failures to disclose:

• that CBL’s main operating subsidiary’s (CBLI) reserves needed strengthening by approximately $100m;
• the existence of approximately $35m of premium receivables due to CBLI that were over a year overdue (and the solvency impact impact); and
• that the Central Bank of Ireland had given a direction to another subsidiary (CBLIE) to apply a capital add-on essentially requiring it to hold additional cash reserves of €31.5m.

Fair dealing vs continuous disclosure vs unsubstantiated representations

The High Court ultimately confined its decision to three instances of non-compliance with CBL’s continuous disclosure obligations.  In the earlier proceedings against the directors, it had been noted that the fact matrix for CBL was the epitome of what the fair dealing provisions and continuous disclosure regime are designed to prevent – and that the breaches undermine market integrity and transparency.  In short, the disclosure failures had meant that investors were wholly unaware of the escalating problems at CBL.  

Again, in those earlier proceedings, the conduct of the directors was found not to be deliberate.  Instead, it was found to be reckless or careless, especially because they were senior and experienced individuals entrusted with the governance of a listed company.

The breaches of the fair dealing provisions appear to have been whittled down in the course of a lengthy hearing involving a very detailed factual matrix.  And, in simple terms, the threshold test for accessory liability for a fair dealing breach appears higher – requiring the accessory to have knowledge that the representation was misleading. 

Interestingly, or ominously, the FMA’s claimed that the fair dealing breaches by CBL were not only misleading – but also that they were unsubstantiated.   Liability for an unsubstantiated representation is separate from that for a representation that is (simply) misleading.  This separate strand of liability crystallises if the maker of the representation does not have reasonable grounds for making (at the time it is made), regardless of whether the representation is false or misleading.    On one level, a claim in respect of unsubstantiated representations can be seen to lie on a spectrum between deliberate and reckless/careless acts or omissions.  In this case, the judgment does not discuss the claim of unsubstantiated representation in detail.  As a result, the only guidance available on this topic is provided in consumer law cases under the Fair Trading Act 1986.

Actual knowledge (of the facts) required

From the judgment, accessory liability for directors and officers will only be arise if the party primarily liable (typically the company) commits a breach – and the person [accessory] is involved in the contravention.

Being involved in the contravention means that the accessory has actual knowledge (including wilful blindness) of the essential facts giving rise to the contravention.  Constructive knowledge is not enough.

The question of the what are the “essential facts” will be very case-specific.  In relation to CBL’s continuous disclosure obligations, the [accessory] must know that:

• the relevant information was not available to the market; and
• it was sufficiently material that a reasonable person would have expected the information, if it were generally available to the market, to have had a material effect on the price of the securities – in other words that the [accessory] must know that the information was ‘material’.

Therefore, accessories (directors and officers) will not be exposed to accessory liability if they did not know that the information was material (or genuinely did not appreciate its materiality).  Because there is a lifeline where a director of officer [accessory] made a judgement call about materiality, but got it wrong (and thereby did not have the requisite level of knowledge) evidence on this point is likely to be put closely under the microscope.

Because accessory liability hinges on knowledge of the essential facts, rather than the law, ignorance of the law (in this case the NZX Listing Rules) rules, or a mistaken belief about the application of the law, may not be a defence.  Consequently, directors and officers need to be aware of the company’s continuous disclosure obligations – including the latest guidance on continuous disclosure.  This includes the various carve-outs from continuous disclosure (e.g. for incomplete negotiations). 

Note that there is an added complexity – because the changes to the NZX Listing Rules that came into effect in June 2019 include a constructive knowledge concept for ccontinuous disclosure obligations – where a director or officer has or ought reasonably to have come into possession of material information in the performance of their duties.

Intentional participation required

The second limb required to establish accessory liability is that of intentional participation in the contravention. This requires acts or omissions that had a “practical connection” with the contravention.

In this case, the CFO was (in three specific instances) found to have acted in a way that had a “practical connection” with the contravention.  This was because he had known that that the Board had not properly considered whether the information should be disclosed.  In other instances, he was found not to have intentionally participated in a breach – where he appeared to have raised specific concerns about the relevant part of a market announcement.

Although not general duty to urge consideration was found – this underlines the risk for officers [senior managers] by staying silent if there is at least a real risk that the Board has not considered, or not correctly considered, their continuous disclosure obligations.  It is possible that such a risk may arise even where officers are not part of the Board’s decision-making process about the decision to make a disclosure, and/or the content of that disclosure.

Statutory defences

The FMC Act provides defences of:

• reasonable reliance on information supplied by another person; or
• taking all reasonable steps to ensure compliance (by CBL with its continuous disclosure obligations).

Because of the Court’s findings about the CFO’s knowledge, his role as CFO – which included being a member of the Disclosure Committee (which was referred to in CBL’s compliance materials – but seemed to operate virtually and in a pretty ad hoc manner) and his omission to raise the need for disclosure with the Board, the Court held that the CFO had not proved that he had taken all reasonable steps to ensure that CBL complied with its continuous disclosure obligations – or that the ‘reasonable reliance’ defence was made out.  

What is not clear is whether a ‘reasonable reliance’ defence might succeed – where the advice in question (i.e. that disclosure wasn’t required) – when the accessory had knowledge of the essential facts of the contravention, and therefore knew the information’s materiality.

Takeaways – the need for careful judgement

Whilst the facts in the CBL case may be seen as extreme, and there is some comfort that actual (and not constructive) knowledge is needed for accessory liability – the takeaway from this decision for those officers in the chain of command for continuous disclosure obligations is that careful judgement is needed.

Putting to one side concerns about hindsight bias – any Court will be required to closely examine “who knew what”.  Decisions about market announcements are often (necessarily) collaborative.  Increasingly, they are made by a dedicated committee.  In this context, policies and procedures are a must have.  As is adequate scope for escalation and documenting the decision-making process. 

The risk, for those officers/senior managers who are aware, or have reasonable grounds to believe, that the Board has not adequately considered disclosure – if that of staying silent when they have the requisite level of (actual) knowledge.  This is what escalation processes are designed for – where there is aware of the relevant information, by seeing that it is brought to the Board’s, and that the Board properly considers whether disclosure is needed.

For more information, please do not hesitate to contact me.