Online defamation: a warning to anonymous posters

A recent decision of the Federal Court of Australia has sent a stark warning to online posters who make defamatory comments under the guise of a fake online alias.  In McCrae v Reynolds [2015] FCA 529, the Court ordered ‘HotCopper’, Australia's most popular stock market internet discussion site, to make discovery of all documents directly relevant to identifying the description of the user known as ‘zzedzz’.

The prospective applicant in the case, Wayne McCrae, is a director of an ASX listed mining company called CuDeco Limited (CuDeco).  In addition to HotCopper, a person known as Edwin Reynolds was named as a respondent, on the basis that Mr McCrae held a reasonable suspicion that Mr Reynolds (under the username ‘zzedzz’) had, over a number of years, posted derogatory comments about Mr McCrae’s management of CuDeco.

These comments, among other things, alleged that Mr McCrae had misled the ASX in respect of deadlines and the ore grade of certain mineral stockpiles.  Mr McCrae had initially been made aware of the posts by a shareholder of CuDeco in early 2013. 

Mr McCrae, via his legal representatives, issued correspondence to HotCopper on two occasions and requested their cooperation in the termination of the ‘zzedzz’ account and for the provision of details regarding the identity of ‘zzedzz’.  These requests were refused on the basis that HotCopper had no obligation to disclose the information. 

The decision in McCrae illustrates how a person can utilise the Federal Court Rules relating to preliminary discovery to compel an operator of a website to disclose the identity of a user who posts defamatory content on that website.                 

Applying the criteria in Rule 7.22, the court found that Mr McCrae:

• had a possible cause of action in defamation
• was unable to ascertain the description of the prospective respondent, and
• had made reasonable attempts to ascertain the description of the prospective respondent, prior to seeking relief from the Court. 

The court found that HotCopper was likely to know the description of the prospective respondent, and therefore thought it appropriate to make an order requiring HotCopper to make discovery of all documents directly relevant to identifying the description of the user ‘zzedzz’.  The decision may yet be appealed, but in the meantime, it is a significant development in favour of those persons who feel aggrieved as a result of an online defamatory post.

Andrew Poulton, Tim Case

Improving disclosure for hybrid securities

The Australian Securities and Investments Commission (ASIC) recently released Report 427 about the relationship between investors’ behavioural biases and their decision to invest in hybrid securities, as compared to less complex financial products such as bonds and shares.  The report, which discusses the findings of a pilot study commissioned by ASIC and produced by Queensland Behavioural Economics Group, builds on earlier ASIC and ASX commentary regarding hybrid securities.

The study was prompted by ASIC concerns that, despite the information made available by ASIC and ASX to the public and improved disclosure by issuers, retail investors are still struggling to understand the complexity of hybrid securities and the risks they pose.

What are hybrid securities?

‘Hybrid’ securities have characteristics of both debt and equity.  Like debt securities such as bonds, hybrid securities offer a fixed or variable rate of return for a specified term.  However, they also include equity-like features proposed to provide investors with a higher rate of return than regular debt securities.  The equity component may arise because they give investors an option to convert the hybrid securities into shares, or because they are accompanied by equity-like risks such as market price volatility and issuer credit risk.  Broadly, hybrid securities fall into the following three categories, either alone or in combination:

• convertible debt securities - debt securities that convert into equity securities
• preference shares - equity securities with debt-like features, and
• capital notes - debt securities with equity-like features.

The multifaceted nature of hybrid securities means they attract a higher level of risk than debt securities, while their inherent complexity may make those risks difficult for retail investors to fully understand.

ASIC has indicated that prospectus disclosure for hybrid securities should be informed by the way investors make decisions.  Regulatory Guide 228 refers to a 2012 paper by the Commonwealth Office of Best Practice Regulation about using behavioural economics to design more effective regulatory interventions, a concept which serves as the foundation for the ASIC-commissioned pilot study and Report 427.

Findings of ASIC Report 427

In the pilot study conducted in May 2014, subjects were tested to reveal their behavioural biases and their perceptions of risk, and then participated in a test of allocating an investment portfolio across bonds, hybrid securities and shares.  The study identified several cognitive and emotional biases that influenced the participants’ decision making with respect to allocating their investment portfolio.  Allocation to hybrid securities:

• increased 14% for participants exhibiting an illusion of control, an ‘unfounded belief that a person can exert control over their environment and influence the outcome of uncertain events’, manifested by believing they could control the risks associated with hybrid securities
• increased 10% for participants exhibiting overconfidence, an ‘unwarranted belief in a person’s own cognitive abilities, intuition and judgment’, manifested by their underestimation of the risks associated with hybrid securities and lack of portfolio diversification
• increased 10% for participants exhibiting framing basis, ‘decision making influenced by the way that choices are presented to a person’, manifested by their choice of hybrid securities over bonds and shares because the risks were less readily apparent, and
• decreased 11% in favour of shares for participants exhibiting ambiguity aversion, ‘preference of known risks over unknown risks’, manifested by their preference for shares over other securities because the associated risks were better understood.

While hybrid securities were perceived overall as more risky than bonds and marginally less risky than shares, only the risk criterion ‘distrust of product/producers’ influenced the participants’ decision not to invest in hybrid securities.  In particular, ‘poor knowledge of the product’ did not discourage participants from investing in hybrid securities.  These findings indicate that behavioural biases have a greater role in investment decision making than perceptions of risk.

What do the findings mean for issuers of hybrid securities?

The findings of Report 427 appear to support ASIC’s concern that, while retail investors may correctly perceive hybrid securities as riskier than debt securities such as bonds, their behavioural biases affect their ability to appreciate the form and scope of those risks in relation to their underlying investment.

ASIC states in the report that the findings will inform their conversations with industry, assist in developing regulatory interventions, and contribute to their programs to educate investors on making more informed decisions (e.g. through ASIC’s MoneySmart website).

No doubt the findings will flow through into further commentary on prospectuses and other disclosure obligations in respect of hybrid securities.  In the meantime, issuers of hybrid securities can at the very least expect additional scrutiny from ASIC on the form and content of their disclosures in the capital raising process.

Budget focus on crowd funding - proposed regulatory framework yet to be settled

Supporting small business is a clear area of focus in the 2015-16 Federal Budget released yesterday.  Among its small business reforms proposed over the next four years, the Government intends to provide $7.8 million to ASIC to develop, implement and monitor a regulatory framework to facilitate the use of crowd-sourced equity funding (CSEF) in Australia.

Building on the Treasury’s discussion paper from December 2014, the Budget acknowledges that CSEF ‘has the potential to increase funding options available to entrepreneurs to assist in the development of their business.’  Since the advent of Kickstarter in 2009, the growth of online, non-equity based crowd-funding platforms within the Australian technology, media and entertainment industries demonstrates an interest among entrepreneurs and investors for alternative sources of capital raising to get start up projects off the ground.

While the Budget contemplates that a CSEF regulatory framework would include simplified reporting and disclosure requirements for raising funds online from a large number of investors, it does not provide further details on the intended framework.  It is encouraging to see further funding committed to this area, but the Government also needs to ensure it does not fall behind its international counterparts (including New Zealand, the UK and the USA) by failing to provide a workable legal avenue for the operation of CSEF in Australia in the near term.

The McCullough Robertson Corporate Advisory team will continue to monitor this area closely for updates from ASIC and Treasury.

ASIC increasing focus on shareholder activism in Australia

New proposed guidance on collective action by institutional investors

ASIC’s recent publication of Consultation Paper 228 and proposed Regulatory Guide 128 (RG 128) appears to be an acknowledgment of the growing trend in Australia towards shareholder activism, which may include collective action by institutional or other major shareholders.  At the same time, ASIC has confirmed its focus on balancing legitimate shareholder engagement, to support good governance, against the potential for shareholders to take steps to obtain control inappropriately (e.g. without paying a control premium).

RG 128 is a useful reminder of the key compliance obligations that apply to shareholders taking such action – with a focus on the substantial holder disclosure obligations and 20% takeover threshold in the Corporations Act – which place limits on the ability for shareholders to act as a collective.

Chapter 14 of The Chairman’s Red Book provides an overview of the takeover threshold test, including an explanation of the key concepts of relevant interest, voting power and associates, which may apply to shareholders taking an activist role or engaging in conduct which may amount to collective action.  If the 20% threshold is exceeded, this will prevent the applicable shareholders undertaking a transaction which would further increase their voting power.

The substantial holder provisions apply where a person and their associates have a relevant interest in 5% or more of the voting shares of a listed company, after which time a person must provide a substantial holder notice to the market, together with further notices for any change of 1% or more in the person’s and their associates holding.  These provisions do not prevent a person holding a 5% (or greater) interest, but rather require disclosure to the market if the threshold is exceeded.

As the relevant interest and associate definitions are broad in scope, there is the potential for the applicable Corporations Act provisions to apply to collection action that relates to corporate governance matters not necessarily undertaken for a control purpose.

ASIC has sought to provide clarity on shareholder conduct likely to be subject to greater scrutiny with the potential to give rise to unacceptable circumstances, despite not contravening the Corporations Act, including:

• conduct involving an actual or proposed control transaction
• replacement of directors (in particular with nominees representing the applicable institutional shareholders)
• actions or resolutions which would benefit only some (but not all) shareholders, and
• situations where the applicable collective of shareholders has a history of taking action together.

RG 128 also provides examples of where ASIC is more likely to consider that an arrangement results in applicable shareholders becoming associates, as against alternative scenarios where ASIC considers that an associate relationship is unlikely to be created.

For example, ASIC has indicated that shareholders who jointly sign a section 249D requisition notice, to replace certain directors, are likely to have entered into a relevant agreement which would make the shareholders associates.  We would, however, be surprised if this is sufficient in the absence of other relevant factors (e.g. a history of prior dealings).  Examples of where ASIC considers collective action is unlikely to result in shareholders becoming associates include shareholders holding discussions or exchanging views on a resolution, or disclosing their individual voting intentions for an upcoming shareholders’ meeting.

Although RG 128 is a useful reference tool for relatively complex provisions of the Corporations Act, it is invariably a grey area which will often turn on the facts.  This is reflected by ASIC’s move towards case-by-case (rather than class order) relief for collective action that may breach the substantial holder and/or takeover thresholds, where ASIC is comfortable such action does not relate to obtaining control over the company.

ASIC has also highlighted some other applicable legal considerations in this area, which include:

• considering the application of the insider trading provisions – in particular, where certain parties have knowledge of a voting agreement, which may itself be price sensitive, but which is not known more broadly by the market
• potential for the creation of shadow directors – where a shareholder or shareholders are exerting significant influence on the conduct of the board through collective action, and
• broader considerations in relation to directors’ duties – which will be an interesting area to monitor going forward, having regard to the fine balancing act between directors potentially acting at the behest of one or more specific shareholders (and so not in the best interests of shareholders as a whole), versus the potential for directors to misuse their position and company funds by taking an overly defensive approach to collective action and other forms of shareholder activism.

It will be interesting to see feedback from stakeholders and industry groups when the consultation process ends next week, with the current proposal for RG 128 to be released in final form in June or July this year.

Harper Review Final Report recommends significant new changes

The Commonwealth Government has been conducting a review of Australia’s competition laws to see if they are fit for purpose. (Click here to see what we had to say about the draft recommendations in The Handshake last October). The Minister for Small Business released the Final Report of the Competition Policy Review Panel on Tuesday (31 March 2015). While a number of the draft recommendations have made it into the Final Report, there are also some significant new changes. Some will fundamentally change the competition law landscape in Australia…if they eventually get into the legislation.

Government procurement

The Panel has recommended that all Government Procurement processes should be subject to competition law and promote competition. At the moment, competition law only applies to Government when it carries on a business. The Panel wants competition law to apply to Government whenever they are undertaking activity in trade or commerce. This will capture one-off transactions, and in particular, Government buying practices. For example, a contract with Government that contained anti-competitive exclusivity clauses would expose the parties to huge penalties if this change were made to the law.

Technology and disruption

The Panel has acknowledged that technology has often done more than competition laws and regulators to bring about competition in industries. A new killer app or device can completely up-end the competitive landscape, even in industries with market leaders who until then have had substantial market power.

In relation to the taxi industry in particular, the Panel endorsed the disruption caused by companies like Uber and essentially called for more of the same, rather than industry protection from disruption.

Key corporate reforms enacted as '100 member rule' finally abolished

On 2 March 2015, the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 (Cth) (Bill) was passed by the Senate and is now awaiting Royal Assent.

The Bill makes several significant changes to the Corporations Act 2001 (Cth) (Act) of which directors, shareholders and practitioners need to be aware. 

Abolition of the ‘100 member rule’

The Bill removes the ability for 100 or more of a company’s members to require directors to call and hold a general meeting at the company’s expense.

The so-called ‘100 member rule’ had previously been widely criticised on the basis that it allowed a very small proportion of a company’s members to disrupt management and impose significant transaction costs on the company even where the resolutions to be considered at a general meeting had little chance of being passed. 

The 100 member rule has not been abolished for managed investment schemes. 

Further, 100 or more of a company’s members are still able to:

• propose resolutions for inclusion on the agenda of general meetings, and
• require the distribution of statements, at the company’s expense, in relation to a proposed resolution or a matter that may be considered at a general meeting. 

The ability for members holding at least 5% of the votes that may be cast at a company’s general meeting to require directors to call and hold a general meeting also remains.

Reporting of executive remuneration

The Bill alters reporting requirements for executive remuneration in an effort to reduce compliance costs and red tape for companies. 

Unlisted disclosing entities no longer need to prepare a remuneration report.  While listed disclosing entities are still required to prepare a remuneration report, in relation to lapsed options, those entities are now only required to disclose the number of options granted to key management personnel as part of their remuneration that lapse during the financial year and the year in which the lapsed options were originally granted.

'Streamlining' amendments

Shortening the financial year

Under the Act, directors can reduce the ordinary 12 month financial year period for the company if the reduction is made in good faith in the best interests of the company, provided that the company’s financial year has not been shortened on that basis alone in any of the previous 5 financial years.

 

For the sake of clarity, the Bill states that, in determining whether a company’s financial year has been shortened in any of the previous 5 financial years, previous reductions of 7 days or less or that were required to synchronise the reporting period of controlled entities to provide consolidated financial reports (also allowed under the Act) are not to be considered.  

 

Auditors for companies limited by guarantee

The Bill clarifies that small companies limited by guarantee and companies limited by guarantee that elect to have their accounts reviewed rather than audited are not required to appoint or maintain an auditor.  This is a logical amendment consistent with provisions of the Act designed to reduce the regulatory burden on companies limited by guarantee.

 

Other amendments

The Bill also enables:

• the Remuneration Tribunal to determine the remuneration of the Chair and members of the Financial Reporting Council, the Australian Accounting Standards Board and the Auditing and Assurance Standards Board, and
• Takeovers Panel members to perform their functions while overseas.

Dividend requirements

The original exposure draft of the Bill contained provisions which:

• introduced a pure solvency test for the declaration and payment of dividends, and
• clarified that a company could make a capital reduction by way of a dividend payment, without the need for shareholder approval, so long as there was an equal reduction to all shareholders. 

Although these provisions were omitted from the Bill as passed, they are likely to be revisited by the Government after further consultation in the future. 

 

For further details on changes under the Bill, please refer to the recent article by Dr Kai Luck.

An overview of securities class actions

Since the first class action in Australia was brought in 1991, class actions have quickly become part of the Australian legal landscape.  Securities class actions in particular have become ‘big business’.  It is prudent now more than ever to review your governance procedures to mitigate the risk of a securities class action. 

A securities class action allows investors of an entity who share common ground for complaint to pursue a claim against the entity through a representative.  The popularity of such actions is at least in part because they allow investors to pursue a claim generally without risk to the investors of an adverse judgment, where they would not otherwise, individually, have the means for doing so.

In Australia, a class action may be brought by seven or more plaintiffs with claims arising out of the same or similar circumstances with a substantial common issue of fact or law – a relatively low threshold comparative to other jurisdictions.  Typically securities class actions are based on the argument that investors either:

• acquired or sold securities where they would not have but for the alleged conduct of the entity, or
• acquired or sold securities at a different price than they would have otherwise acquired or sold securities but for the alleged conduct.

These arguments are most frequently based on two causes of action, often pleaded together:

• misleading or deceptive conduct under section 1041H Corporations Act, by way of inaccurate or incomplete statements, or a failure to disclose or correct information in a timely fashion, and
• in the case of listed entities, breach of continuous disclosure obligations under section 674(2) Corporations Act and ASX Listing Rule 3.1, by way of a failure to disclose information where a reasonable person would expect that information to have a material effect on the price or value of securities in the entity.

Since 1999 there have been 30 securities class actions in Australia, of which only four have proceeded to trial and none to judgment.  Entities and their investors often elect to settle early due to the costs of litigation and the uncertainties as to the outcome of a judgment, particularly as the required evidence to establish causation in a securities class action has not yet been considered by the courts. 

A key feature of the Federal class action regime is that it is designed to allow an applicant to represent an ‘open class’ of investors without the need for investors to take steps to ‘opt in’ to proceedings.  Every person who satisfies the class definition as described in the originating process is represented in the proceeding subject to a right to opt out by a fixed date.  However, the inherent difficulties ascertaining the number of investors and the quantum of their cumulative damages means the open class model leads to a lengthy, uncertain litigation process.  The alternative approach adopted in some cases is a ‘closed class’ action, where the class is limited to those who have retained a specific law firm and/or entered into a funding agreement with a particular litigation funder.

Several circumstances have given rise to an increase in securities class actions in Australia.  Firstly, there has been an increase in the number of plaintiff law firms focusing on securities class actions, especially in the wake of a decline in personal injury practice following legislative reforms.  Secondly, there has been a steady increase in third party funding of securities class actions spurred by the High Court’s approval of such funding in Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd [2006] HCA 41.  Anyone can now fund litigation except the lawyers involved in the case, with IMF (Australia) Ltd, Legal Funding LLC, International Litigation Partners Pte Ltd and Harbour Litigation Funding facilitating some of the major class actions in the last decade.  Thirdly, there is a growing focus on private litigation as a means by which to enforce good corporate governance rather than relying on regulatory bodies.  Increased institutional investor participation, particularly in listed companies, will only heighten this focus.

Several entities have been the subject of multiple securities class actions, emphasising the need for entities to take precautions to protect themselves against the risk of litigation from investors.  Some common issues that have prompted securities class actions and that should be on the radar for entities include:

• lack of reasonable grounds for statements in financial reports about expected profitability of the entity ¹
• failure to properly disclose to the market the full extent of costs increases and delays associated with an entity’s projects²
• failure to disclose to the market the full extent of an entity’s debt obligations and refinancing options,³  and
• failure to disclose price-sensitive information relevant to an entity’s significant earnings downgrade.⁴

Securities class actions is a developing area of law that underlines the need for entities to be accountable to their investors.  Continuous disclosure obligations place listed entities in particular at risk of a securities class action and, as such, listed entities should have appropriate procedures in place to monitor and anticipate potential issues.  These procedures may include:

• maintaining an up to date, comprehensive and easily understandable continuous disclosure policy for the company
• establishing effective internal reporting networks to ensure price sensitive information is quickly communicated to the board, senior managers and other decision makers in the company, and
• ensuring that the board regularly considers information that may need to be disclosed to the market, such as by including continuous disclosure as a standing item on the board agenda.

 

1. Aristocrat; Sigma Pharmaceuticals; River City Motorway Group. 
2. Downer EDI; Multiplex.
3. Centro.
4. GPT.