Last week the High Court struck out a representative claim against the FMA brought by a minority shareholder in Du Val Property Group. The claim was based on negligence as well as an implied statutory duty – and alleged that the FMA breached of a duty of care by the regulator in relation to the debt-for-equity swap that was apparently offered to investors in the Du Val Mortgage Fund.
A number of the comments that follow are in qualified terms, because there are still many details relating to the backstory of the Du Val entities that are not in the public domain (yet). And the nature of strike-out applications, typically at an early stage in the litigation process, means that the court is often dealing with a subset of the evidential background and full arguments and that ultimately emerge should a claim go to a “full” hearing.
Outcome unsurprising
The headline outcome of the judgment is that the judge found that the FMA owed the claimant[s] no particular duty of care with regard to its dealings with the Du Val entities (and presumably their directors and officers) and that to find otherwise would create an insurance scheme for investors at great cost to taxpayers. It would likely also have a chilling effect on the actions of the FMA as the frontline financial regulator.
This outcome is (on its own) unsurprising, given the main takeaway from the 1995 Court of Appeal decision in Fleming v Securities Commission that the FMA’s predecessor must exercise its discretion as to how it goes about its numerous functions, and to impose a duty of care would interfere with that discretion.
The decision is also consistent with the landmark dismissal of a class action brought against the Australian financial regulator (ASIC) after the GFC, arising out of the collapse of a finance company (Storm). In that case, the class actin claimants alleged that ASIC knew, or ought to have known, that Storm was failing to comply with its [disclosure] obligations and that ASIC should have warned investors of the risks, or taken regulatory action against Storm, in order to protect investors from the losses they suffered arising from their Storm investments. In striking out the claim, the Australian Court found that, as a general rule, a statutory authority that is under no positive legislative obligation to exercise a power will not have a duty of care to third parties, unless by its conduct the authority places itself in a position that attracts a duty of care, and consequently calls for the exercise of that power.
Supposed green light
Central to claim by the minority shareholder in Du Val Property Group was a 2 July 2024 letter sent by the FMA sent to the Du Val entities at the tail end of what appeared to have been a lengthy interaction by the FMA relating to the debt-for-equity swap offered to investors in the Du Val Mortgage Fund, when interest payments in the Mortgage Fund had been suspended, which was coupled with an indication that Du Val would look to list on the NZX.
In summary terms, the FMA had been concerned that the information provided to investors about the debt-for-equity swap was likely to mislead and deceive because of a number of omissions. It first published a public warning to this effect in March 2023.
After further interaction, and in the face of an indication from the FMA to Du Val in April 2024 that it was considering issuing a ‘direction order’ under the FMC Act, the Du Val entities were said to have taken a number of corrective steps – including by addressing feedback from the FMA on a draft of supplementary disclosure material which was described (by the FMA) as being intended to ensure that the information provided to the investors was presented “in a clearer and more balanced way” and with “more detail” in some areas. In doing so, it offered those investors who had accepted the debt-for-equity swap – the opportunity to back out (i.e. to retain their stake in the Du Val Mortgage Fund).
In the 2 July 2024 letter, the FMA advised that it had decided not to issue a ‘direction order’ as a result of the further information that Du Val had provided to investors – which it said had addressed its concerns. The 2 July letter also said it had decided not to make a media statement in relation to those concerns.
The minority shareholder claimed that they interpreted the 2 July 2024 FMA letter as a green light to go ahead (and accept the debt for equity swap). By doing so, they had effectively gone from being an unsecured creditor of the Du Val Mortgage Fund to a minority shareholder in Du Val Property Group. Put bluntly, they were now last in the queue as a result of the shoes that began to fall only a month later – with the FMA initiating the appointment of receivers (and the subsequent statutory management).
The minority shareholder continued by claiming that the 2 July 2024 FMA letter and the decision not to issue a ‘direction order’ was a breach of the duty of care the FMA owed to investors in the Du Val Mortgage Fund. That is, they claimed that the FMA failed to exercise the necessary skill and care in carrying out its functions under the FMC Act and the Financial Markets Authority Act 2011 – a claim in negligence and/or as a breach of its implied statutory duties under the FMA Act and the FMA Act.
Claim struck out
Part of the difficulty with the claim about the significance of the 2 July letter appears to evidential (and timing). Limited by the nature of a decision on a strike-out claim, it appears that the minority investor accepted the debt-for equity swap by April 2024 (at the latest), did not take up the opportunity to back out in May 2024 – and the FMA’s letter was not issued until July (and was a private letter to Du Val – with no public statement).
The judgment contains an analysis of the building blocks for deciding whether a duty of care exists in novel cases like this one, requiring a two-stage approach to be taken:
- First stage: Look at the relationship between the parties, to consider issues of foreseeability and proximity.
- Second stage: Look at externalities affecting the parties, which only comes into play if the court has found that the loss was foreseeable and sufficiently proximate. To decide whether, because of factors external to the relationship of the parties, it is unfair / not just and reasonable – to impose a duty of care.
Despite having serious doubts as to whether the minority shareholder’s loss was reasonably foreseeable to the FMA, the judge examined the issue of proximity and rejected the claim that the FMA’s engagement with Du Val resulted in a relationship between the FMA and the Du Val Mortgage Fund investors that was sufficiently proximate to give rise to a duty on the FMA for two reasons:
- First: There was no close connection between the FMA and the Du Val Mortgage Fund investors – because there was no “direct involvement” by the FMA in the affairs of the Du Val Mortgage Fund investors. Instead, the FMA’s dealings were all with Du Val or, in the case of the March 2023 warning, with the public at large.
- Secondly: The FMA is required to exercise its functions in the general public interest – and could not just consider the position of the Du Val Mortgage Fund investors. It needed to consider the position of all the investors and creditors of Du Val, and even the effect that the collapse of the group might have on the market more generally.
Having rejected the claim of a duty of care, for completeness the judge also canvassed the relevant externalities, and concluded that these also pointed strongly against imposing a duty, because:
- Perverse incentive: If the FMA became subject to a duty of care whenever it became involved in the affairs of issuers, it would create a perverse incentive on the FMA to avoid getting involved if at all possible. And when the FMA did become involved, this would similarly incentivise it to act in risk-averse manner – which would inhibit it from properly carrying out its functions.
- Indeterminate liability: Such a duty of care would expose the FMA and (other regulators) to indeterminate liability to the risk of claims from a very large number of investors.
- No insurance scheme: Imposing a duty would create an insurance scheme for investors at great cost to the taxpayer. This, he continued, would be particularly inappropriate in the present case – because the investors who were offered the debt-for-equity swap had invested in the Du Val Mortgage Fund were ‘wholesale investors’ (and by definition capable of looking after their own disclosure needs).
No [statutory] implied statutory duty of care
The judge, relying on the same reasons as those for rejecting the claim of a common law duty of care, rejected the claim of an implied statutory duty of care under the FMA Act and from the “statutory context as a whole”.
Concluding comments
Whilst the decision, in the context of a strike-out application, is broadly consistent with cases dating back to the aftermath of the 1987 crash and, more recently, the Storm decision in Australia after the GFC, it is also interesting to note the judge’s misgivings as to whether the green light letter in July 2024 caused the minority shareholder’s loss.
Whilst Du Val had, on 22 May 2024, offered those investors who had accepted the debt-for-equity swap – the opportunity to back out, the judge noted that if the FMA had warned investors, the minority shareholder might have done so (and retained their stake in the Du Val Mortgage Fund). But an FMA warning and any indication that Du Val may have been insolvent would have caused a panic which would have made it highly unlikely that the minority shareholder could have backed out of the debt-for-equity swap.
The FMA also argued that the minority shareholder would have lost its investment even if the debt-for-equity had not occurred – because they would have been an unsecured creditor, ranking behind secured creditors and there would have been a shortfall to unsecured creditors. But, the judge noted, there was no evidence to show whether this is correct.
Presumably, in due course, we will learn more about the level of knowledge that the FMA had about Du Val’s circumstances.
A decision in the case stated proceedings brought by the FMA seeking clarity on the use of ‘eligible investor’ certificates, must be imminent and should provide further clarity about activities in the wholesale market.
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