An Australian Federal Court decision at the end of April, involving ASX Listed software business Nuix Limited, provides more lessons about the practical application of continuous disclosure obligations and earnings guidance.
It also appears to provide some vital points of difference with some of the (frankly alarming) connotations of the decision in round 3 of the shareholder class action (Brambles) – at the start of April.
Background
Nuix undertook an IPO and listed on the ASX at the end of 2020. The IPO prospectus contained some ambitious earnings forecasts for its (June) 2021 financial year. By January 2021, a little over a month after the IPO, Nuix share price had more than doubled that for the IPO. But the share price fell after the release of its half-year results in February 2021 – at which time Nuix reaffirmed its IPO prospectus forecasts. Those forecasts were reaffirmed again in March 2021.
In April 2021, Nuix issued an earnings downgrade – at which point the share price fell even further.
The Australian regulator (ASIC) brought proceedings alleging breach of Nuix continuous disclosure obligations. ASIC did not take issue with the IPO prospectus forecasts. Instead, it alleged a breach of continuous disclosure obligations from mid/late January 2021 to mid/late April 2021, for:
- non-disclosure of reduced earnings for the 2021 half-year by approx. 10% less than the IPO prospectus forecast;
- the reaffirmation of the IPO prospectus forecast in February and March 2021; and
- alleged delays in publishing the April 2021 earnings downgrade.
Outcome
In summary, the Federal Court found that:
- ASIC had failed to establish that the provision of the 2021 half-year earnings figure was material to investors (because the IPO prospectus forecast only provided a full-year earnings forecast);
- ASIC had failed to establish that the process undertaken by Nuix was not a genuine assessment of the likely earnings for the 2021 financial year; and
- while the half-year earnings figure was below expectations, there was (at the key times) a reasonable belief that full-year 2021 earnings forecast could be achieved.
Consequently, there was a reasonable basis for the forecasts provided and, to the extent that there was a deviation from the forecasts, the deviation was below the 5% materiality threshold – and (as a result) did not need to be disclosed.
Equally importantly, the Court found that the exceptions in ASX Listing Rule 3.1A to the continuous disclosure obligation clearly applied to the relevant information prior to earnings downgrade. As discussed below, the same exceptions apply to the continuous disclosure obligations under the NZX Listing Rules.
A number of Australian commentators have described the Nuix decision as a reaffirmation of key elements of the relevant ASX guidance on continuous disclosure and the significance of the 5% materiality threshold. It also underlines the importance of robust forecasting processes.
Key points from the Nuix decision
The key points that can be distilled from the decision include:
- Forecasts: are a statement of opinion about a metric at a future date. A later forecast is not inconsistent just because it generates a different number. As a result, companies should not be faced with [the absurdity] of having to disclose tiny variances in respect of forecasts – instead, the disclosure obligation is triggered where the difference must be material.
- Materiality: The ASX guidance is critical, and a variance of less than 5% should not be presumed to be material (and trigger a disclosure obligation). See the comments at the foot of this not about the contrary decision in the Brambles decision. Note that ASIC argued that a variance of less than 5% could still be material, which judge in Nuix was contrary to commercial reality – whereas the NZX guidance indicates that this is not a brightline test and simply notes that deviations from an issuer’s own guidance below 5% will not usually be material.
- Paper trail: Nuix had established a solid evidential platform (more than just a paper trail) that proved that it had a reasonable basis for its forecasts. Importantly, while there is no single way to prepare a forecast and there may be differences of opinion – the genuineness of the result (forecast decision) is a matter of substance over form. Evidence of a robust forecast process, reasonably applied, was needed. ASIC argued that Nuix sat on a revised forecast for 12 days (crafting the message) – the judge disagreed and concluded that the evidence showed that the finance and sales teams spent weekends stress-testing and refining the forecast. In short, an issuer is entitled to take the time to be satisfied as the robustness of its earnings forecast before disclosing the details to the market
- Process/approach: expert’s opinions about the appropriateness of the process (method) may differ, but:
- they key elements of any model (such as the underlying assumptions) require judgment calls – about which experts may reasonably differ;
- (in this case) the differences of expert option didn’t point to the process used by Nuix as being unreasonable;
- the Nuix team who undertook the work were very familiar with the subject matter, and were [suitably] qualified and experienced – and, by contrast, ASIC’s expert acknowledged that they did not have the same inside knowledge. This counted against any conclusion that Nuix did not have reasonable grounds for its forecast.
- Listing Rule carve outs: ASX Listing Rule 3.1A was applicable, and contains a carve out (from the requirement for prompt disclosure) on a number of identified criteria, including where the information contains matters of supposition or is insufficiently definite to warrant disclosure, or is generated for internal management purposes. The same carve outs apply under the NZX Listing Rules. Much of the evidence brought by ASIC was internal documents labelled [DRAFT – FOR DISCUSSION] and containing preliminary numbers for review and for completing the forecasts. This was insufficiently complete/definite and generated for further discussion by management – and when taken together with Nuix’s evidence on its ongoing (and thorough) review process, meant that it fell within the carve out and did not require disclosure.
Takeaways
The practical takeaways from Nuix must include:
- Rigour: The rigour applied to budgeting and earnings guidance processes (top down / bottom up, etc) is key – and, because there is no single right way, a substance over form approach requires thoroughness.
- Genuine: Because there is no, single, right way and experts can differ – the process must be, and be seen to be, genuine.
- Paper trail: As well as a proper paper trail, working documents must be labelled appropriately – and clearly labelled (such as Draft / for internal discussion purposes) to ensure reliance on the carve outs. The key point being that a continuous disclosure obligation should only crystallise when a final (formal) landing is arrived at. (But this must be genuine).
- The 5% materiality threshold: Issuer are entitled to rely on the guidance that a variance of less than 5% will not usually be material – unless there are exceptional circumstances. See the discussion below about the Brambles decision.
- Evidence: Nuix’s witnesses were accepted as qualified, informed, experienced and competent – whose views were accepted (likely because they were based on up-to-date and hands’ on experience).
- Differences of opinion: If there are differences of opinion (of key matters) between those preparing and receiving the material, as there may be, these should be documented and as part of the process at the time – not after the event when all of the usual questions and the risk of hindsight bias may arise. (This appears to have been a problem in Brambles).
Contrast with the Brambles decision
Nuix is to be contrasted with the Brambles decision, earlier in April, where a Federal Court judge held that the ASX guidance was no more than a rule of thumb and merely a guide, with the result that a 1.2% variance was still material.
The judge in Brambles also discounted the evidence of management witnesses as ‘self-serving’. This was not helped by the number and content of incriminating documents, with numerous contemporaneous emails questioning the basis and/or validity of the forecasts which those witnesses tied to back track from and explain, years later, in the proceedings.
By contrast to Nuix, Brambles was a shareholder class action case – relating to earnings’ (and underlying profit) guidance and statements about medium-term targets. That guidance was reiterated, reaffirmed or maintained in further announcements for many months – and then a quarter after the last reaffirmation, it was withdrawn triggering a large fall (approx. 16%) in the share price. A further earnings downgrade a month later resulted in a further fall of approx. another 12%.
Finding that Brambles breached its continuous disclosure obligations, in light of repeated budget failures, consistently missed reforecasts, and “unrealistic” recovery assumptions (which contrasted with evidence of contemporaneous internal warnings), the judge found that Brambles did not have reasonable grounds for the guidance it reaffirmed and maintained.
The judge said that an approach grounded in “commercial common sense” was needed and the continuous disclosure obligations did not permit a wait and see approach to the disclosure of material information to the market. In doing so, the judge treated the ASX guidance with considerable caution, rejecting Brambles’ defence that the variations did not reach the 5% to 10% thresholds of materiality set out by the ASX – and emphasising that the ASX guidance was no more than a rule of thumb and that it did not displace the requirements under the ASX Listing Rules.
Concluding comments
A number of Australian commentators have said that Brambles is likely to be appealed. And the ASIC prosecution in Nuix is likely to have a bearing on a shareholder class action that is also in the pipeline. Nonetheless, Brambles is seen as an outlier based on a number of earlier Australian decisions.
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