Continuous Disclosure Obligations - is knowledge, recklessness or negligence required?

The following article was published by Lexology on 8 May 2023:

The Federal Court recently handed down the largest-ever penalty against a company for breaching continuous disclosure laws. The court ordered GetSwift Limited to pay $15 million for contravening s 674(2) of the Corporations Act 2001.

The court found that GetSwift breached its continuous disclosure obligations on 22 occasions between February and December 2017. Amongst other allegations, GetSwift failed to update the market about losing materially significant contracts.

Other cases recently in the news include ASIC commencing civil proceedings against Freedom Foods Group, now Noumi Limited, its former managing director, CEO, and former CFO.

The company allegedly failed to disclose material information about the value of inventories in its financial reports for the full year ending 30 June 2019 and the half year ending 31 December 2019. It is also alleged to have failed to disclose material information about its sales revenue, gross profit, and profit after tax in its financial report for the half year ending 31 December 2019. ASIC alleges Freedom Foods' former CEO, and CFO misled investors, auditors, and directors and allowed their company to breach continuous disclosure laws by failing to disclose a significant write-down, leading to an uninformed market.

In another case, Medibank shareholders have taken legal action against the private health insurer, alleging non-disclosure of cybersecurity deficiencies. In a massive data breach, hackers stole the sensitive health records of almost 10 million Australians.

ASIC is also investigating possible disclosure rule breaches at share market operator ASX Ltd. The investigation follows pulling a blockchain-based overhaul of its trading, clearing, and settlement system despite years of assurances that the project was on track.

All these cases act as a reminder of the importance of complying with continuous disclosure obligations - not just for companies but also for directors and officers of the company.

What is the obligation of continuous disclosure?

Where the continuous disclosure obligation applies, the obligation requires an entity to assess the materiality of emerging, non-public information about the entity, and, if it is material to the entity’s share price or value, disclose it to the market.

This obligation is set out in section 674 of the Corporations Act 2001 (Cth). Failure to comply with this section is an offence.

What type of information must be disclosed?

The listing rules explain "information" as follows:

Information may include information necessary to prevent or correct a false market. It may also include matters of supposition and other matters that are insufficiently definite to warrant disclosure to the market and matters relating to a person's intentions or likely intentions.

Examples of the type of information that should be disclosed

The cases mentioned in the introduction to this article give recent examples of the type of information that should be disclosed. Other types of information include:

• A transaction that would lead to a significant change in the nature or scale of the entity’s activities.
• A material acquisition or disposal.
• The granting or withdrawal of a material licence.
• Becoming involved in a material lawsuit.
• Under or over subscription to an issue of securities.

This list is by no means exhaustive. Listing Rule 3.1A provides that Listing Rule 3.1 does not apply to particular information where certain situations are satisfied relating to that information (see for more comprehensive list, Listing Rule 3.1A). Legal exceptions to the obligation to disclose, include:

• It would be a breach of law to disclose the information.
• The information is a trade secret, etc.

What is meant by "material effect on price and value"?

Section 677 of the Act defines material effect on price and value as follows - the information would have a material effect on the price or value of securities if the information would, or would be likely to, influence persons who commonly invest in securities in deciding whether to acquire or dispose of the securities.

Deciding what is material or not is a matter of judgment and context. In the past, companies faced huge compensation claims in class actions based on what a reasonable person would expect. The class action members had to prove that a "reasonable person" would have expected the information to have a material effect on the share price or value of the entity. That was a relatively low threshold.

There was no requirement of "fault" on the part of the entity to institute civil action against an entity. It was not necessary to prove that the entity knew or expected that the information would have such an effect.

The "new" requirements for civil liability

In August 2021, Parliament amended the provisions around the obligation of continuous disclosure. These amendments were partly to curb increased class actions against companies.

The amendments introduced a 'fault" requirement. Section 674A added "the entity knows or is reckless or negligent" with respect to whether the information would, if it were generally available, have a material effect on the price or value of the entity.

When is knowledge, recklessness or negligence required?

Companies and their officers are still obligated to disclose any information concerning the entity that is not generally available if a reasonable person would expect the information to have a material effect on the price or value of the entity's securities.

Regarding criminal sanctions for failure to do so, the requirements of section 674 apply, i.e., the reasonable person test to determine if the breach of the obligation of continuous disclosure would have a material effect on the price and value.

The knowledge, recklessness or negligence requirement is not required in criminal proceedings against the entity.

Section 674 requirements also apply when ASIC issues an infringement notice for a contravention of section 674. No knowledge, recklessness or negligence is required to proceed with administrative measures where the entity must pay administrative penalties.

Section 674A's knowledge, recklessness and negligence requirements apply in civil penalty proceedings.

Companies will now only be liable to pay civil compensation or pecuniary penalties for breach of continuous disclosure obligations if the plaintiff can prove:

• the company had knowledge of information that was material (price sensitive) to the market; or
• it acted recklessly or negligently with regard to information that would have a material effect on the price or value of the entity.

It remains to be seen how the courts will interpret and deal with the amendments when dealing with civil penalty proceedings. It would be interesting to see how the negligence test will differ from the reasonable person test when determining a "material" effect.

General principles when imposing civil penalties

In the GetSwift case, the infringement occurred before the maximum penalties were increased in March 2019. Nevertheless, Justice Lee set out the general principles for imposing pecuniary penalties.

• The primary (if not sole) purpose of a civil penalty is the promotion of the public interest in compliance with the provisions of the Act in question by deterrence of further contraventions of that Act.
• The court has discretion, and when determining the quantum of the penalty, the following factors are considerations:

1. The nature and extent of the contravening conduct.
2. The amount of loss or damage caused.
3. The circumstances in which the conduct took place.
4. The size of the contravening company.
5. The degree of power it has, as evidenced by its market share and ease of entry into the market.
6. The deliberateness of the infringement and the period over which it extended.
7. Whether the infringement arose out of the conduct of senior management or at a lower level.
8. Whether the company has a corporate culture conducive to compliance with the Act in question, as evidenced by educational programmes or other corrective measures in response to an acknowledged contravention.
9. Whether the company has shown a disposition to co-operate with the authorities responsible for the enforcement of the Act in question in relation to the contravention.

The court pointed out that this is not a "rigid catalogue" - there must be some reasonable relationship between the theoretical maximum and the final penalty imposed. The key is the overriding need to focus on what is necessary for specific and general deterrence. The penalty must not be such that it is regarded as "an acceptable cost of doing business".

Takeaways from recent developments

Although it might be more difficult for shareholders to bring a civil action against a company and its directors or officers, listed companies, and their directors and officers are still obligated to disclose information that a reasonable person would expect to have a material impact on the price or value of securities.

Failure to do so can result in criminal prosecution, administrative proceedings, and penalties.

Any company or director knowingly, recklessly, or negligently involved in an entity not disclosing material information can also face civil penalties and compensation claims.

Directors must ensure they comply with their section 674 and 674A continuous disclosure obligations and always be mindful to disclose information that will give the public and investors the full picture when deciding to invest in the company.

As we have previously suggested, in light of the new “knowledge” and “recklessness” tests, boards may, now more than ever, benefit from carefully documenting their deliberations (or at least their reasons) with respect to decisions concerning continuous disclosure.