Continuous disclosure vs COVID-19: the welcome introduction of a due diligence defence

Continuous disclosure is a complex issue at the best of times, but the COVID-19 environment has added another layer of complexity about what needs to be disclosed to the market. The issues are novel compared with the ‘usual’ continuous disclosure issues you are used to dealing with. Some of these issues could easily be overlooked and lead to significant consequences, such as class actions or regulatory penalties.

In this four-part series, we will discuss the various continuous disclosure obligations you need to be aware of. In the first article, we look at the Federal Treasurer’s Determination which provides welcome relief to company directors and officers in relation to continuous disclosure obligations, and explore whether these temporary amendments to the regulatory framework should be introduced on a permanent basis moving forward.

Continuous disclosure compliance is a consistent challenge for disclosing entities, and one that has caused heightened concern over recent years, let alone in the present turmoil facing almost every industry and business as a result of the COVID-19 pandemic. Directors and senior management are not only grappling with what changes need to be made to their business in response to the pandemic, but also the information that needs to be announced to the market in a timely manner.

Recent judicial decisions, such as the Myer^[1] class action, have set a high standard for corporate entities and their officers in terms of adhering to their continuous disclosure obligations. In Myer, the court approved the concept of market-based causation, thereby lowering the burden imposed on individual shareholders to prove loss in class action proceedings. This has removed what was otherwise a significant potential hurdle for class action litigants and funders.

While the impact of COVID-19 has triggered disclosure obligations that most company officers are ordinarily attuned to, such as updating or withdrawing earnings guidance, the pandemic has also raised more novel disclosure issues. Some of these issues could easily be overlooked where, understandably, the main focus of directors and management in this environment is the ongoing viability of their business, maintaining shareholder value and looking after other stakeholders (most notably employees).

In early April 2020, the Australian Institute of Company Directors (AICD) published a proposal that sought to address some of these issues by introducing a temporary safe harbour in relation to continuous disclosure obligations. The AICD advocated for a temporary amendment to the Corporations Act 2001 (Cth) (Corporations Act) that would allow only ASIC to take action against listed disclosing entities, or their directors and officers, in relation to earnings guidance or forward-looking statements about company performance, provided that these disclosures were made in good faith. It certainly appears as though members of the Federal Government took notice of these suggestions, as one month later substantive action on continuous disclosure obligations was taken.

Specifically, on 26 May 2020 the Federal Treasurer, Josh Frydenberg, issued the Corporations (Coronavirus Economic Response) Determination (No. 2) 2020 (Determination). The Determination provides company directors and management with enhanced protection from breaches of continuous disclosure obligations (and costly class actions) in the face of continuing economic uncertainty resulting from the COVID-19 pandemic. Although these measures are only temporary, they reignite debate as to whether similar protections should continue beyond the present circumstances through the creation of a ‘due diligence defence’ that is available to be used in respect of continuous disclosure obligations.

Current state of play

Sections 674 and 675 of the Corporations Act set out the continuous disclosure rules that apply to all disclosing entities. Chapter 3 of the ASX Listing Rules applies similar (albeit not identical) obligations for listed entities.

Critically, and subject to certain exceptions, sections 674(2) and 675(2) of the Corporations Act require listed and unlisted disclosing entities to immediately disclose information that:

• is not generally available; and
• a reasonable person would expect to have a material effect on the price or value of the securities of the entity.

Liability under these provisions extends not only to the entity itself, but also to any person who is involved in the contravention of these continuous disclosure obligations, such as directors and officers.

Very limited protections are afforded to those involved in a contravention. This is cause for concern for many officers of disclosing entities (especially listed entities), with an actual or possible breach of continuous disclosure obligations having the potential to expose an entity and the officers themselves to significant financial and reputational consequences in an environment where class actions are prevalent.

What are the protections available to company officers as a result of COVID-19?

The Determination temporarily amends the Corporations Act to include a standard of fault for continuous disclosure breaches.  This should provide diligent entities with a greater level of confidence that they can adhere to their continuous disclosure obligations during the pandemic, provided they have taken reasonable steps in considering whether information is price sensitive.

To achieve this, the objective assessment applying to continuous disclosure obligations has been replaced by a new temporary test, commencing on 26 May 2020 and remaining in force for six months.

Specifically, the Determination raises the threshold so that information is only subject to a continuous disclosure obligation if:

This means that civil penalties should not be imposed if an entity takes reasonable steps (essentially undertaking an appropriate level of due diligence) in respect of whether the relevant information is ‘price sensitive’. However, listed companies and other disclosing entities must remain cautious and exercise care in this new regime, given that:

• The laws on misleading and deceptive conduct have not been amended, and the ASX Listing Rules currently still retain the existing test. This inconsistency with the Listing Rules essentially means that what needs to be disclosed to the market by listed disclosing entities remains the same, but that civil penalties may not be imposed under the Corporations Act unless an entity has knowingly, recklessly or negligently breached its obligations.
• Many shareholder class action litigants also allege that the disclosing entity in question has breached the continuous disclosure provisions on the basis that it failed to form a view on whether it was aware of material information, a claim that may still hold weight under the ‘negligence’ limb of the temporary test.
• It will be important to have a documentary trail of the reasonable steps that have been taken in order to be able to rely on the defence, and this should be recorded contemporaneously and not in retrospect.
• The modifications under the Determination do not affect the operation of criminal offences. However, liability under these provisions only arises where there has been an intentional breach.

Should these protections be extended or enhanced beyond COVID-19?

The Determination has the potential to alleviate some of the short term angst many directors and officers were facing with respect to potential shareholder class actions. In doing so, it may refocus the spotlight on the inconsistencies under the Corporations Act in relation to the available defences relating to statements made by listed entities on ASX. Currently, a due diligence defence exists for misleading or deceptive statements in certain documents regulated by the Corporations Act (such as a prospectus or PDS), providing a level of protection from liability where all reasonable enquiries were made. However, there is no equivalent defence for other documents released to the market (such as announcements, investor presentations or information memoranda) in accordance with an entity’s continuous disclosure obligations.

Although the Determination appears to assist in reducing the risk of vexatious and capricious class actions in the short term, more could be done to address this issue permanently. Entities and directors should, in our view, be provided with some level of statutory protection where they have been diligent in complying with the continuous disclosure obligations and all reasonable steps have been taken to ensure compliance based on the information known to the company at the relevant time (as opposed to assessing what ought to have been known with the benefit of hindsight). It will be interesting to monitor whether the Determination will raise any further questions and spark further changes at a federal policy level.

Despite this uncertainty as to whether this will become a more permanent reform, it appears for the time being that disclosing entities, as well as their directors and other officers, will benefit from a level of comfort to confidently keep the market updated during these uncertain and volatile times.

[1] TPT Patrol Pty Limited as trustee for Amies Superannuation Fund v Myer Holdings Limited [2019] FCA 1747.