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MANIFESTLY UNJUST: THE CONVICTION AND CRIMINALISATION OF HONEST MEN ___________________________________________________________________________

E W Thomas The Rt Hon Sir Edmund Thomas LLB(NZ) LLD(VUW) KNZM QC, retired Judge of the Court of Appeal and former Acting Judge of the Supreme Court. Distinguished Fellow at the Law Faculty, University of Auckland.* ___________________________________________________________________________ In Jeffries and Ors v the Queen ([2013] NZCA 188) the Court of Appeal disallowed the appeal of the directors of Lombard Finance and Investments Ltd against their convictions of an offence under s 58 of the Securities Act 1978 and allowed the cross-appeal of the Crown against the sentences imposed by the trial Judge. Sentences including home detention were substituted. In this article the author examines the Court’s judgment. He argues that the Court’s grasp of the facts is incomplete and it’s reasoning suspect or flawed in a number of respects. The conclusion reached is that the convictions and sentences represent a miscarriage of justice. ___________________________________________________________________________

CONTENTS

1 The bank lock-up in February and March 2008 2 The collapse of Lombard 3 The directors are convicted and sentenced 4 Risk and loss 5 The fundamental principle of the criminal law 6 Lombard’s good governance 7 The amended prospectus 8 A brief note on the facts 9 The “sin” of omissions 10 Where to draw the line 11 The bank lock-up revisited 12 The Peden schedule

 

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12.1 The Peden schedule – fairness

12.2 The Peden schedule – substantive flaws

13 An illogical omission 14 Impairment and liquidity 15 The directors’ obligation to existing investors 16 The statutory defence 17 Reasonable grounds 18 The wisdom of hindsight 19 The sting in the tail 20 Concluding remarks

“The right not to be criminalised is a basic human right that aims to protect individuals from unwarranted state interference of a penal nature. The right is not only a basic right, but it is also a fundamental legal right.”

Glanville Williams1

1 THE BANK LOCK-UP IN FEBRUARY AND MARCH In February/March 2008 the financial marketplace in New Zealand took a “violent and negative turn” known as the bank lock-up.2 It was unprecedented and unpredicted. Banks ceased lending or advanced loans selectively at high interest rates. The complex interbank overnight loan market froze and interbank lending was largely curtailed. At the same time, offshore investors, a prime source of monies for the banks in this country, ceased or reduced funding to local banks. The banks responded by increasing their retail deposit rates to attract cash. It was described as a “scramble for cash”.3                                                              *The author wishes to thank those who have read and commented on a draft of this article for their considerable assistance. 1 Denis J Baker, Glanville Williams (3rd Ed.) Textbook of Criminal Law (Sweet & Maxwell; Thomas Reutrers, 2012), 3-004, p [80].

2 Wallace, Brief of evidence, p 21.

3 Wallace, Notes of evidence, Vol. 5, p 2747. 

 

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The impact on the marketplace was sudden and drastic. Prospective purchasers of properties were unable to obtain finance. In many cases the banks withdrew offers of finance causing purchasers to default. The property market fell dramatically. In the result, the non-bank deposit taking sector, which had controlled some $11 billion of investments in property, was largely destroyed. The impact on finance companies, such as Lombard, was fatal. Developers whose developments were funded by the company were no longer able to obtain or replace funding with bank finance at a lower interest rate as their developments neared completion or were completed. When the banks refused to lend for that purpose or increased their interest rates to a level which made refinancing unfeasible, the developers ability to sell the remaining sections or units, or to rollover sections or units pending sale, or to sell down properties on completed projects, virtually disappeared. The consequences of the lock-up for Lombard were disastrous. Developers, however well managed and monitored, defaulted in their obligation to repay the loans. Speaking in January 2009, Dr Alan Bollard, then Governor of the Reserve Bank of New Zealand, said:

Financial institutions became increasingly unwilling to deal with each other as uncertainty about who was exposed, and how badly, became more and more enlarged… As 2008 progressed… [m]easured regulatory capital that had seemed bountiful up until 2007, now looked thoroughly inadequate.4

We now know that the bank lock-up in early 2008 was the harbinger of the global financial collapse which occurred later in 2008. The global financial crisis is generally dated from the decision of the United States Administration not to bail out Lehman Brothers in September of that year. It is true that BNP Paribas was in trouble in August 2007, but the shadow banking system did not collapse until up to a year later. Northern Rock in the United Kingdom received assistance with its liquidity from the Bank of England in mid-September 2007 but the Bank was not nationalised until February of the following year. In New Zealand a number of finance companies had failed in 2006 and 2007, but it was the collapse of Bridgecorp in July 2007 and Nathans Finance in August of the same year that had any significant impact. In 2007 few persons, including economists, predicted the global financial crisis.5 No one, it seems, predicted the bank lock-up in February/March 2008.6 This unprecedented and unpredicted bank lock-up was the proximate cause of Lombard’s collapse.

                                                            4 Speech to the Canterbury Employers Chamber of Commerce on 30 January 2009. See Appleby, Brief of evidence, para.15.2.

5 The surplus of books on the global financial crisis on the author’s bookshelf, courtesy of Amazon.com, testifies to this fact. But that is not to say that the number of economists who now claim to have predicted the GFC has not increased exponentially since that time!

6  It is true that the Governor of the Reserve Bank had issued public warnings that there would be “correction” in the escalating prices current in the housing market. House and property prices would not continue to rise forever. (For a review of the Governor’s statements, see E W Thomas “A Critique of the Reasoning of the Supreme Court in GE Custodians v Bartle”, New Zealand Business Law quarterly (2011) Vol. 17, No. 2, pp 113-114.) But nothing that was said up to the end of 2007 contemplated the “violent and negative turn” constituting the bank lock-up in February/March 2007.  

 

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2 THE COLLAPSE OF LOMBARD On 19 December 2007, the date of the last meeting of the Board in that year, the directors approved the terms of an amended prospectus designed to update investors as to the more difficult trading conditions. It was issued on 24 December, and is the offer document that was to become the centrepiece of the court proceedings when Lombard collapsed. As will become clear, the directors were well aware that the market had hardened in 2007. They knew that the difficult trading period was not over. But they were confident that the company had the capacity to get through this difficult period. The company had just under $9 million in cash reserves, which was in line with its rule of thumb policy of holding about ten per cent of secured debenture stock in cash. Its overall financial position in December had improved since March 2007. Major loans were to be repaid early in the New Year and the company’s largest exposure, in respect of a development which had some problems, had been bought out by experienced developers in November. Four different cash flow projections which had full regard to developments up to that time were before the Board. A cash flow chart for the ensuing year demonstrated that there would be positive and rising cash balances throughout 2008, particularly after March. Adopting a conservative approach, the directors believed the company had the liquidity to ensure that it could meet its interest and repayment obligations as they fell due. Even the Governor of the Reserve Bank, Dr Bollard, could contemplate that the market had corrected itself. In his book on the financial crisis he recounted; “The markets were quiet, and we ended 2007 anxious but hoping that the worst was behind us.”7 But, along with everyone else, the directors had not foreseen the bank lock-up. Dr Bollard later said:

The picture for New Zealand and Australia did not look so serious at this stage. The northern financial markets were urgently trying to identify the holders of toxic subprime assets. They concluded that most of these were in North America and Europe. To them, Australasia seemed toxin free. ....8

In March 2008, with developers ceasing to have access to lending from the trading banks and prospective purchasers unable to obtain loans for the purchase of sections in the developments, Lombard’s financial position quickly deteriorated. The directors responded promptly and ordered an urgent review of the quality of the company’s loan book. Within a matter of weeks the company discontinued taking deposits. They suspended the prospectus and amended prospectus, which had been issued on 24 December 2007, and placed deposits that had been received on trust for investors. A moratorium proposal was prepared by Minter Ellison and presented to the Trustee, Perpetual Trust Ltd, with the support of KordaMentha. The Trustee took advice from Mr Fisk and, on 10 April 2008, the company was placed in receivership. Mr Fisk was appointed one of the receivers. 3 THE DIRECTORS ARE CONVICTED AND SENTENCED After an investigation by the Securities Commission, the directors, Sir Douglas Graham, the Hon William Jeffries, Lawrence Bryant, and Michael Reeves were charged with an offence under s 58 of the Securities Act 1978. On 24 February 2012, after a trial which began on 17                                                             7 Alan Bollard, with Sarah Gaitanos, Crisis: One Central Bank Governor & the Global Financial Collapse (Auckland University Press, 2010) at p 35. 

8 Appleby, Brief of evidence, para. 6.29

 

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October 2011 and finished on 3 February 2012, Dobson J convicted each of the four directors. Section 58(1) makes it an offence to issue a prospectus which includes an untrue statement. The offence is one of strict liability. But subs (2) of the same section provides a defence if the statement was immaterial or “the accused had reasonable grounds to believe, and did believe, that the statement was true”. Dobson J held that the statutory defence had not been made out.9 Dobson J accepted that there was nothing in the amended prospectus that was untrue. Indeed, the amended prospectus clearly warned investors that a collapse of the property market might result in the loss of their capital. Recourse was had to s 55(a)(ii) which provides that a statement is “deemed” to be untrue if it is “misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is included.” Notwithstanding that he accepted that failure to meet the projections included in a forecast was not critical because the timing of receipts contemplated in the forecast were not “drop dead dates”,10 Dobson J held that the prospectus was misleading by reason of the omission of information relating to a perceived downwards trend over a short period in the company’s cash balance and the omission to report the timing of, or delays in, loan repayments as against the dates projected for repayment. He held that this information would be material to an investor’s decision to invest in Lombard. Two other charges were strongly pressed by the Crown. The Crown contended that a number of loans were adversely impaired. It also contended that the directors had failed to adhere to the company’s lending and credit policies. Dobson J dismissed both charges.11 The convictions entered against the directors, therefore, related solely to the question of the company’s liquidity.12 The Judge sentenced the Chairman, Sir Douglas Graham, and Mr Bryant to 300 hours community work and reparation of $100,000. The other non-executive director, the Hon Mr Jeffries, and the executive director, Mr Reeves, were sentenced to 400 hours community work. The directors appealed against their convictions to the Court of Appeal. The Solicitor-General filed a cross-appeal against the sentences arguing that they were manifestly inadequate. The appeal was heard by Randerson, Wild and French JJ in March of this year. Randerson J delivered the judgment of the Court on 30 May 2013. The Court dismissed the directors’ appeals and allowed the Solicitor-General’s cross-appeal. It held that it was open to the trial Judge to conclude that the statements in the amended prospectus were misleading and therefore untrue by reason of the omission of certain particulars; the sharp deterioration and serious downward trend in the company’s cash position; the pattern of serious delays in the recovery of loan repayments; the significant discrepancies between the projected timing of loan repayments and their actual receipt; and the extent of the directors’ concern about these matters.13

                                                            9 The Queen v Graham and Ors [2012] NZHC 265, Reasons for Verdicts of Dobson J, [124] – [146].

10Ibid, [111].

11 Dobson J did hold that one loan was impaired but considered the impairment immaterial, [211].

12 Jeffries and Ors v The Queen [2013] NZCA 188, [4, (4)]. 

13 Ibid, [149] -[153], [161] - [164], [170], [184] and [195].

 

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The Court recited the section in the amended prospectus relating to the liquidity risk in full.14 No particular statement in the amended prospectus is identified as the statement which is rendered misleading. Rather, the Court held that the prospectus relating to liquidity, read as a whole, created an “impression” which is “important”.15 To the extent that any statement is marked out for attention it is a sentence in a paragraph which refers to the possibility of market confidence in the finance sector continuing to decrease, particularly if there were further failures of finance companies and a decrease in new investment and renewals below the levels that Lombard was currently achieving. These events, it continued, could impact on liquidity. The sentence which then follows reads; “The Board remains confident that, based on a range of conservative scenarios, Lombard Finance will have the required cash resources to fund all repayments to investors when due and they are not reinvested.” While the risks had been indentified, however, the Court held that the amended prospectus did not convey the “imminence” of them.16 It repeatedly endorsed the view that the prospectus did not indicate the particularly “vulnerable state” of the company.17 The Court of Appeal endorsed Dobson J’s finding that the amended prospectus was not misleading in not referring to the “specific cash balance as at the date it was issued or any other date around that time”.18 This was “because there were significant fluctuations in the cash balance from day to day and because there were other factors impacting on the relative adequacy of the cash balance”.19 The Court was not, however, inhibited from detecting a trend in these fluctuating cash balances. Of course, the “buffer” built up by the company had been depleted, as had been expected, but care is required in proclaiming a trend when that trend is based on a comparison of one fluctuating cash balance with the next fluctuating cash balance over a relatively short period of time. The extent of the alleged omissions in this case, and the generality of the respects in which the amended prospectus is deemed to be untrue, gives rise to difficulties which the Court does not appear to have fully comprehended, especially in the context of the question whether the directors had reasonable grounds to believe the prospectus was true, as will appear below. Having allowed the Solicitor-General’s cross-appeal, the Court substituted the following sentences; Sir Douglas Graham, 6 months home detention and 200 hours community work; Mr Bryant, 6 months home detention; the Hon Mr Jeffries, 8 months home detention and 250 hours community work; and Mr Reeves, 9 months home detention and 250 hours community work. The orders for reparation against Sir Douglas and Mr Bryant were allowed to stand. The thrust of this article is that there are serious deficiencies in the Court’s scrutiny of the facts and in its reasoning, which led to fatal errors of law. The deficiencies extend beyond the question of guilt and intrude into the Court’s decision to increase the sentences imposed

                                                            14 Ibid, [57].

15 Ibid, [57] and [89].

16 Ibid, [89], [99] and [171].

17 Ibid, [50], [144], [163], [168], [171], [196] and [246].

18 Supra n 9, [117].

19 Supra n 12, [61]. 

 

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on the directors. The deficiencies are of such an order as to represent a miscarriage of justice. If we continue to abhor injustice, the Court’s reasoning cannot be spared a close examination. 4 RISK AND LOSS Risk is inherent in our economic system. The Long Title to the Companies Act 1993 specifically refers to the assumption of risk. Finance companies are not immune from risk. Indeed, the higher interest rates payable on loans to finance companies recognises the increased risk of investing monies with such companies. The return is greater but so, too, is the risk. Yet, although finance companies serve a valuable economic purpose,20 the reality of the risk inherent in the regime does not sit comfortably with our knowledge of the limitations of many investors; some will be financially naive, some will heed ill-informed advice, some will be misled by advisers who are in a position of conflict, some will be seduced by advertising or promotions that have no direct bearing on the governance or prospects of the company, and some, if not most, will hold unreasonable expectations as to the security of their investment. A range of statutory and regulatory provisions have been enacted to protect the innocent investor. The Securities Act is one such enactment. It seeks to minimise the risk to investors but, of necessity, it does not and cannot eliminate that risk. The Minister of Justice moving the second reading of the Securities Advertising Bill (now Securities Act 1978) said as much when the Bill was before Parliament:

The purpose of the Bill is not to ensure investors against loss. Risk is an inseparable part of an investment, and the Bill in no way purports to alter that. But I do not regard as legitimate that part of the risk attributable to irresponsibility or mismanagement.21

When Lombard went into receivership in March 2008, it owed investors approximately $125 million.22 Of this sum, some $10.5 million had been reinvested (8.4 per cent) and $1.7 million deposited by way of new investments (just over 1 per cent) after the issue of the amended prospectus on 24 December 2007. Nonetheless, the Crown placed great emphasis on the total loss to investors. It produced direct evidence from investors who had suffered a personal financial calamity as a result of the company’s collapse. Their evidence is heart rending. Some had lost their life savings. It is impossible not to feel considerable sympathy for the investors. Their desire to see someone brought to book, even if it would not result in any monetary recompense, is understandable. To them, the fact the company in which they had invested their hard earned savings had collapsed must mean that the board or managers, or both, were responsible. Someone must be held accountable. Sympathy can readily shade into empathy. For those who are themselves investors, although not necessarily investors in a finance company, it may be impossible not to feel a degree of

                                                            20 Finance companies provide an economy with risk capital which is essential for economic growth.

21 Hon David Thompson, Minister of Justice, moving the Second Reading of the Securities Advertising Bill (now Securities Act 1978), Hansard, Vol..421, p 3934, 27 September 1978.

22 Made up of $111 million of secured deposits, $10 million unsecured deposits, and $4 million capital notes. (Of this total, $2 million were held by the company’s parent group).

 

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empathy for the investors, even subconsciously. After all, the investors are blameless. It seems manifestly human to believe that someone must be to blame for their plight. Strict intellectual rigour is required to avoid a predisposition to feel that someone must pay. But the questions in issue are questions requiring the same judicial mien as other cases involving the criminal law. Readers, therefore, who cannot accept that a finance company may collapse without someone being held responsible, need read no further. It would be a waste of time. Readers who can accept that a finance company may fail through no fault of its directors or management, however, will gain a perception of the facts and the legal arguments in the Lombard case that is not apparent from a reading of the Court of Appeal’s judgment. They will encounter a version of the facts and perceive a strength in the legal arguments favouring the directors which is lacking in the judgment. 5 THE FUNDAMENTAL PRINCIPLE OF THE CRIMINAL LAW The fundamental principle of the criminal law, repeated in all textbooks on the subject and endorsed in too many cases to cite, is that its purpose is to punish and deter conduct which is intentional or reckless. Hence, the requirement of mens rea.23 Glanville Williams points out that increasing insistence on some element of wrongful intent or other fault is the mark of an advancing civilisation.24 It is, of course, open to the legislature to enact an offence of strict liability and from time to time it is prone to do so. Mostly, as the textbooks affirm, the offences are not serious and generally apply to regulatory misconduct.25 Although it is customary to refer to s 58 as an offence of strict liability, it is to be stressed that it is only subs (1) that falls within that description. That subsection is moderated by the statutory defence in subs (2). But accepting that s 58(1) is an offence of strict liability and therefore dispenses with the need for mens rea or reckless behaviour does not mean that this basic principle of the criminal law can be brushed to one side. The fundamental principle is still relevant to the interpretation and application of the section Of course, the principle cannot be invoked to undermine, constrain or otherwise limit the strict liability of the offence under s 58(1). What the principle does allow, if not mandate, however, is that the offence should not be interpreted or applied in a manner which does more than give effect to that strict liability. Such an approach is pertinent when the issue is whether particulars have been omitted which render the prospectus misleading. Even more clearly, the principle is pertinent to the interpretation and application of the statutory defence under s 58(2). The defence breaks out from the confines of strict liability. The word “reasonable” in the phrase “reasonable grounds to believe”, while to be determined objectively, can be properly interpreted and applied consistently with the fundamental function of the criminal law.

                                                            23 Supra n 1, 4-001, p [95] and 5-001, p [119]. See also Andrew Ashworth, Principles of Criminal Law (6th ed.) Oxford University Press, 2009) pp 6-7, and A P Simester and W J Brookbanks, Principles of Criminal Law (3rd ed.) (Brookers, 2007), para. 1.3.2, p 9.

24 Glanville Williams, supra n 1, 4-001, p [95].

25 E.g., Simester and Brookbanks, supra n 23, para. 5.1, p 139.

 

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Parliament seems to have been fully cognisant of this basic principle. The Minister of Justice in the above quotation referred to “irresponsibility and mismanagement” being necessary to displace the risk to the investor.26 The Opposition Spokesperson, Mr Richard Prebble, said;

I support the Government on this clause [now s 58] ... Most companies are honest, and honest reputable companies have nothing to fear about the measures in the Bill.27

Nor should it pass unnoticed that Parliament is in the process of repealing s 58 and substituting an offence which will require mens rea or recklessness on the part of the issuer of offer documents. The principle is self-evidently pertinent to the sentencing of the directors. When the Court of Appeal opines that “denunciation” and “deterrence” is necessary to denounce and deter honest, unintentional and non-reckless conduct, the only tenable conclusion possible is that this basic principle of the criminal law has been neglected. In their excellent text, Simester and Brookbanks note that guilt through conviction is the distinguishing mark of the criminal law. The pronouncement connotes fault on the part of criminal.28 When the courts find an accused guilty of committing a crime and punish him or her through sentencing, there is, observe the authors, a “public implication” that he or she is blameworthy.29 It is difficult to imagine a case where the public implication that the accused are blameworthy of a crime has been more evident than in the case of the directors of Lombard. They have been roundly regarded as criminals in the media and mercilessly lumped in with directors who have been dishonest or fraudulent. Judges can, of course, remain aloof. They can say that, while they have found the directors guilty of an offence of strict liability (forgetting for a moment the statutory defence), they have expressly declared that they were honest and that their conduct was unintentional. If, therefore, the media and commentators choose to report the matter in terms that portray the directors as “criminals” and assume that they have been dishonest and their conduct deliberate, that is not their responsibility. Such a response would no doubt appeal to the purist. But such aloofness is framed by indifference. The point that is missed is that the public perception reflects the fundamental principle that the basic function of the criminal law is to punish dishonest and intentional or reckless conduct. To neglect the setting in which the law operates is to neglect the wisdom embedded in the essential function of the criminal law. 6 LOMBARD’S GOOD GOVERNANCE

                                                            26 See above n 21. 

27 Hansard, Vol. 421, p 3938, 27 September 1978.

28 Simester and Brookbanks, supra n 23, para.1.3.2, p 7.

29 Ibid, p 8.

 

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Corporate good governance is quite properly seen to be an imperative.30 Much of the Companies Act is directed to achieving that objective. On the basis of the evidence, Lombard’s governance is difficult to fault. The Board met monthly and established a number of committees, such as an Audit Committee, Credit Cell Committee, and a Major Loans Committee to monitor the progress of major loans. Evidence was given by Mr Wallace, a person with considerable commercial and financial experience, that the governance of Lombard was as good as anything he had seen.31 Evidence was also given that Sir Douglas was an effective and efficient Chair of the Board. Apart from other boards on which he served, Sir Douglas was on the Board of the New Zealand Superannuation Fund. A witness, Mr Newman, who had extensive business experience and who is on the board of a number of major companies, had been a director on that Board with Sir Douglas for close to seven years. Sir Douglas had been the Deputy Chairperson and Chairperson of the Audit Committee. Mr Newman described him as the most diligent director he had ever worked with. He was, Mr Newman said, a totally professional director who brought an “overall wisdom” to the Board table. His conclusion was that Sir Douglas was an outstanding director.32 Lombard employed experienced staff, including loan managers with proven expertise in the management of loans and the supervision of developments. It also employed highly qualified officers to arrange for the receipt of funds and to prepare forecasts for future repayment (“financial asset maturity profiles”). The Board adopted a conservative lending policy. It adhered to its flexible guideline of retaining ten per cent of secured debenture stock in cash. Cash as at March 2007 was 12 per cent, in August it had peaked at 17 per cent and, as at the date of the amended prospectus, it was just under 8.7 per cent, which was considered within an acceptable range. Unlike a number of finance companies, Lombard had never defaulted. It had no related party loans and did not undertake offshore lending. Needless to say, the directors did not make loans to themselves or their friends. Nor did they take out dividends not long before the company went into receivership. Indeed, all net profit after tax was retained. This retention meant that, on receivership, the shareholders, including capital note holders, owned about a quarter of the loan book and ranked after investors. Cash flow projections and the reasons for them were subject to extensive scrutiny, both by the Large Loans Committee and the Board itself. The questioning was described in evidence as “very, very intense”.33 Detailed discussion followed. Various options for the repayment of loans were explored and pursued. As mentioned by the Court of Appeal in recounting the evidence of the receiver, the cash projections were subject to frequent change. Indeed, the cash projections were updated on a daily basis during the last quarter of 2007.34 The directors

                                                            30 For an excellent treatise on corporate governance in relation to banks, see John Farrar, “Improving the governence of financial institutions” in Regulatory Failure and the Global Financail Crisis: An Austalian Perspective (Eds. Mohamed Ariff, John Farrar and Ahmed M Khalid) (Edward Elgar Publishing Ltd., 2012), Chap 8, at p 127.

31 Wallace, Brief of evidence, p 26. 

32 Newman, Notes of evidence, Vol. 6, pp 2937-2939.

33 Beddie, Notes of evidence, Vol. 4, p 2254.

34 Supra n 12, [103].

 

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adopted measures designed to achieve the repayment of loans. Loans were rarely advanced for more than 12 months so as to enable the company to monitor the progress of the developments. The repayment of loans was, as the Court of Appeal noted, dependent either on the completion of borrowers’ development projects and the subsequent sale of properties in that development or by the borrower refinancing.35 These factors meant that cash flow forecasts had to be continuously revised. Expected payment dates depended on numerous matters such as the completion of codes of compliance, settlements of sales, mismanagement by developers which would have to be rectified, and the like. Loan repayments were not included in forecasts unless there was reasonable certainty that they would actually be received, and if loan repayments became uncertain they were deleted from the forecasts. The company adopted a conservative provisioning policy. The number of loans which had been written off was negligible.36 Some loans that had been written off were later recovered.37 As acknowledged by Dobson J, the Board did everything possible to optimise the prospect of the ultimate repayment of loans.38 It is, perhaps, worth interposing an observation as to the noticeable difference in the approach of the directors and the Courts which emerges from the evidence and the ensuing judgments. The Courts looked backwards perceiving in the delayed repayments a “trend” or “pattern”39 whereas the directors, while fully aware of the delays, looked forward to the expected date of completion and focused on information relating to the progress being made towards the completion of a development. The inevitable delays in repayments did not signify a loan failure. Unlike many other finance companies, Lombard employed only what was described as “Tier 1” professional advisers. Perhaps as a result, the evidence showed that security documentation was of a high standard and that the company’s financial records were exemplary. The company worked closely with its advisers in the normal course of business and in the preparation of offer documents; Phillips Fox and Minter Ellison to prepare and advise on offer documents, Buddle Findlay to prepare loan documentation, and KPMG as auditors. Indeed, Dobson J noted that the company was “almost profligate” in the use made of external advisers.40 The company also worked closely with the Trustee, Perpetual Trust Ltd, providing it with weekly reports relating to liquidity, asset quality, maturity profiles, reinvestment rates, and debenture maturity profiles. Until it went into receivership in April 2008, Lombard had never defaulted in any way and had fully complied with the Trust Deed. It responded promptly to enquiries from the Securities Commission, providing it with monthly reports and, as from September 2007, along with other finance companies, weekly reports containing details of the

                                                            35 Ibid, [29].

36 Graham, Brief of evidence, para. 51, p 12.

37 Ibid.

38 Supra n 9, [242].

39 Supra n 12, [61], [69], [76], [89], [152], [162], [164], [170], [176], [190] and [195]. 

40Supra n 9, [138]. 

 

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company’s financial position. External auditors were kept fully informed and any directions received from them were complied with. Because it could foresee the tightening conditions in the financial market, and having regard to the profile of the loan book and likely completion dates of funded projects, the Board built up its reserves from $19 million in March 2007 to a peak of $39 million in August of that year to assist liquidity during the anticipated tight period from September 2007 into the early months of 2008. Loan receivables were reduced from $162 million in March 2007 to $145 million in September of the same year. The company’s secured debenture liability was also reduced from $152 million to $138 million between these dates reducing debt pressure. In September 2007 the directors commissioned Ferrier Hodgson (now KordaMentha) to conduct a peer review of its liquidity. Ferrier Hodgson’s reported on 18 September 2007. It adopted the company’s cash flow projections noting that there was $33 million in cash on hand as at the date of the review and that this would “maintain a liquidity buffer over the next 12 months” provided it was able to collect the forecast loan repayments on schedule.41 The report then said that assumptions made about the timing of repayments were “not unreasonable”. Variances from expectations could be expected and it recommended that the projections should be regularly revised as circumstances dictated.42 On the basis that the market would stabilise and that Lombard would be able to differentiate itself as having better investment products than other finance companies, new deposits were expected to recover at a rate of approximately $500,000 per month by February.43 The Court of Appeal acknowledged that the Ferrier Hodgson report provided some comfort to the directors. It did not contain anything of which they were not already aware.44 The directors decided in December 2007 to issue an amended prospectus disclosing the increased risk to investors in the more difficult environment following the collapse of the finance companies to which reference has already been made. In preparing the amended prospectus the directors obtained comprehensive professional advice. Dobson J held that the directors acted honestly in issuing the amended prospectus and “genuinely” believed the prospectus to be true,45 a finding that was accepted by the Court of Appeal.46 There is no suggestion that the directors acted other than in accordance with the established principles of a directors duties to act honestly, responsibly, prudently and in good faith. Nor is there any suggestion that the directors were irresponsible or imprudent for failing to monitor the company’s financial position or for not foreseeing the unprecedented lock-up in the banking sector in early 2008 or the widely unforeseen global financial collapse later in the year.47                                                             41 Supra n 12, [38].

42 Ibid, [38].

43 Ibid, [39].

44 Ibid, [122]. 

45 Supra n 9, [125] and [329].

46 Supra n 12, [163] and [230]. 

47 The Parliamentary Commerce Committee issued a Report in October 2011 entitled “Inquiry into finance company failures”. Apart from macroeconomic factors such as the downturn in the property market and global credit crunch, the causes of the failures identified by the Committee were, in short, poor governance and management of risk, criminal misconduct, and the exploitation of investor risk. None of these causes applied to Lombard.

 

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Clearly, Dobson J and the Court of Appeal struggled to perceive the relevance of the company’s good corporate governance to the question whether the amended prospectus was true and whether the directors had reasonable grounds to believe it was true. But good governance is pertinent. The courts must, as must directors, make a decision as to what particulars should be included, and what particulars can be omitted, in an offer document without rendering the document misleading. Section 55(a)(ii) mandates this exercise. Because judges have little, if any, commercial or financial experience they should, as freely acknowledged in other settings, be cautious about second-guessing the directors and management of a company that obtains a high standard of corporate governance. The good governance of the company is relevant to the question whether the amended prospectus is misleading by reason of omitted particulars. A company that is well run with a conservative approach and policies is less likely to be in error in assessing the liquidity requirements of the company. If, to take an example, all the loan managers explanations for the delays in repayments were sound, as the directors believed to be the case, the deterioration and alleged trend in the company’s cash position, the alleged pattern of delays in the recovery of loan repayments, and the discrepancies between the projected timing of loan repayments and their receipt, tend to lose the force they might otherwise have. Finally, good governance is particularly relevant to the question whether the directors had reasonable grounds to believe that the amended prospectus was true. The company’s good governance is effectively the starting point for that enquiry. Take a random selection of some of the features of the company’s good governance; the fact the company barred related party loans, or that the directors prudently built up its cash reserves as a “buffer” against the hardening market conditions, or that they ran down the company’s loan exposure, or that the loan managers asserted what might fairly be called a micro-management approach to the progress of major developments, or that the directors adopted a conservative approach to the recovery or impairment of loans, and so on. Singly, and in combination, such aspects of a company’s governance constitute grounds for the directors’ reasonable belief that the section on liquidity in the amended prospectus was true. The assumption must be that a company that is well run and adheres to conservative policies is in a better position to withstand a correction in the housing market than one which is not. In short, the directors of Lombard were entitled to approach the question as to what the offer document should, or should not, contain in the knowledge of the high standard of corporate governance which they had implemented, and the Courts were remiss in not acknowledging that feature. Lombard’s good corporate governance is both the context for the question and informs the answer. 7 THE AMENDED PROSPECTUS Space does not permit the whole of the part of the amended prospectus entitled “Liquidity risk” to be set out in full as in the Court of Appeal’s judgment. It must suffice to refer to those parts specifically relating to the risk of Lombard not having the liquidity to meet its obligations as they fell due. The account of the risks and the warnings relating to those risks will be found to be surprisingly extensive by readers who have previously relied on media reports of the Court’s judgment. The amended prospectus states that, in the event Lombard failed to manage its liquidity, due to mismanagement of its own borrowings (deposits from investors) or matured loans not

 

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being repaid on time, there could be insufficient funds to repay investors. Should the loss of liquidity be of a magnitude to cause Lombard to become insolvent, there could be insufficient funds to repay investors. To understand cash flows it is important to look at the cash flow statements in the accounts attached to this prospectus.48 The prospectus recites that Lombard’s investing and operating activities produced a cash surplus for the year of $14.603 million (after adjusting for the $2.632 million decrease in loans and advances) and $1.453 million in the six month period to 30 September 2007 (after adjusting for the $18.097 million decrease in loans and advances). The prospectus then records that Lombard managed its liquidity by regularly updating its projections of the maturity dates of amounts owed to investors, the proportion of investors that will redeem, as opposed to reinvest, their investments, the loan repayments received from borrowers (often from the expected sales of completed developments), and the further advances made to borrowers including further advances made as part of funding developments. As at the date of the amended prospectus, it is reported correctly, Lombard did not have significant commitments to fund on-going developments. It is noted that reports were provided to the Board weekly and were available to the Credit Committee. It is then stated that, in common with other companies in the finance sector, Lombard was currently experiencing a reduced level of reinvestment by investors than that which had applied twelve months before. This statement is then elaborated. It is pointed out that cash flow projections were completed on a conservative basis, that is, “a lower level of reinvestment is used for this purpose than is currently being experienced and allowances are made for delays in borrowers repaying their loans”. It is then expressly stated that in the current circumstances “the sales of properties are being delayed”. A specific warning relating to market confidence in the finance sector follows. The amended prospectus states that if confidence continues to decrease, particularly if there were further failures of finance companies, new investment and renewals may decrease below the levels that Lombard was currently achieving and that this could impact on liquidity. The prospectus then affirms the directors’ confidence that, based on a range of conservative scenarios, Lombard would have the required cash resources to fund all repayments to investors when due and that are not reinvested.

The risk is further elaborated. It is spelt out that a period of constrained liquidity will also impact on the company’s capacity to lend and is likely to negatively impact on Lombard’s future growth and profitability. The company’s policy of reducing exposure is reported, there being a reduction in current loans made by the company from $167.6 million on 30 September 2006 to $144.3 million on 30 September 2007. The section on liquidity concludes by emphasising the risk of a further loss of confidence. It is printed in bold in the prospectus:

There is a risk that a further loss of confidence in the finance sector could result in investors materially reducing their level of reinvestment below that assessed by Lombard Finance. If that was extreme, Lombard Finance would not be able to refund

                                                            48 Oddly, the Court of Appeal failed to refer to the accounts attached to the amended prospectus although they are relevant to show the cash held as at 30 September 2007. This was the date specified in the indictment, but the Court departed from that date and had regard to the period from March to December to trace the “trend” or “pattern” it found in forecasts and repayments, that is, from $40 million to $9 million rather than from $24 million to $9 million.

 

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its repayment obligations unless other funding was available or asset realisations/borrower repayments were accelerated.

None of these statements are untrue. 8 A BRIEF NOTE ON THE FACTS The focus of any appeal is always likely to be directed at the legal questions which arise. The legal issues are traversed in this article. But that does not mean that the facts are not important. Indeed, in a case such as the present a full understanding of the facts is vital. There is much wisdom in the old adage; get the facts right and the law will look after itself. More often than not, a close examination of the facts not only reveals the merits of the case but also points to a just decision:

The truth is that a close knowledge of the facts is essential ... as a prerequisite to doing justice in the particular case. The facts are the fount of individual justice. Vast areas of fact are commonly examined by judges which have little or nothing to do with the question of precedent. But those facts will be intensely examined nonetheless because judicial experience confirms that it is essential to focus on the facts in order to arrive at a just decision.49

The evidence in the present case fills several volumes and it is as complex as it is voluminous. A judicial disposition of the appeal admits of no alternative but to assimilate and digest these complex facts. It is a prerequisite to both determining whether the amended prospectus is true and not misleading and whether the directors had reasonable grounds to believe it was true. In this regard, the Court of Appeal’s grasp of the facts seems to have been somewhat tenuous. It is true that in upholding the trial Judge’s conclusion that the statements in the prospectus are untrue and his finding that the appellants had not established the statutory defence the Court relied upon the principle that “having regard to all the evidence” the Judge could reasonably have been satisfied to the required standard that the directors were guilty.50 There is no present need to cavil with this principle. Accepting it for present purposes, the principle nevertheless presupposes that the appellate court will undertake a thorough scrutiny of the evidence and obtain a close knowledge of the facts. This task is not difficult in the more conventional criminal cases, such as murder, rape or robbery. The facts are manageable. But in a case like the present where the evidence is voluminous and the facts extraordinarily complex the task must nevertheless be undertaken. Sheer volume and complexity cannot justify a “once over lightly” approach to the facts. One observation should be touched upon as it obtained wide publicity. Both Dobson J and the Court of Appeal quoted an email from Sir Douglas Graham to the Chief Executive sent in November 2007 in which he said that, although everyone was working hard to get the loans repaid or refinanced, the fact was that the company was “sailing very close to the wind”. Read in context, this remark is indicative of the level of the Chairman’s concern, confirms                                                             49 E W Thomas, The Judicial Process: Realism, Pragmatism, Practical Reasoning and Principles (Cambridge University Press, 2005) at pp 321-322.)

50 Supra n 12, [140].

 

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that he was monitoring the situation carefully, and demonstrates that he recognised the next few months would be critical. As he explained in evidence, he accepted that the company was heading into a critical period and he felt he had to make certain everything was correct.51 For anyone connected with yachting, sailing close to the wind does not mean that the yacht is in danger of sinking. 9 THE “SIN” OF OMISSIONS Reliance upon omissions is burdened with difficulties that do not beset the straightforward case where it is alleged that a positive statement in a prospectus is untrue. In such a case the statement is either true or untrue. The question can be determined objectively on the facts. The task is far less simple when the question is whether the statement is to be deemed to be untrue by reason of omitted particulars. While that question is also to be determined objectively on the facts, it requires a degree of assessment on the part of the courts that the more straightforward cases under s 58(1) do not require. In relying on s 55(a)(ii), the Courts’ had to identify the statement or statements in the amended prospectus which were to be deemed untrue. An example that would meet the requirements of s 55(a)(ii) interpreted literally would be a reference in a prospectus to a loan without stating it was a related party loan. That fact would clearly be a “particular” material to the “statement” in the prospectus “in the form and context in which it is included”. The Court of Appeal’s judgment suffers from the fact that the Court never fully grasped the complexity of its task. In the first place, in seeking to identify a statement or statements for the purposes of s 55(a)(ii), the Court of Appeal was a little more specific than Dobson J. But the Court ultimately tended to rely on that part of the amended prospectus dealing with the liquidity risk read as a whole and the overall “impression” it created.52 While the Court recited the particular statement that, based on a range of conservative scenarios, the directors were confident Lombard would have the required cash resources to fund all payments to investors when due, it did not rest its reasoning on this one sentence.53 Ultimately, it is the amended prospectus in relation to liquidity read as a whole which creates the misleading “impression”. It is not clear, and the Court did not make it clear, whether it intended to overrule the dicta of Venning J in R v Petricevic and Ors54. Venning J said; “... The omission relates to the statement, but it does not replace the requirement for a statement in the first place. It is not an offence to omit something from the prospectus unless the omission makes a statement in the prospectus untrue.” Certainly, Venning J adhered to the literal wording of the statute. Section 55(a)(ii) specifically refers to a “statement” in the prospectus being deemed to be untrue and the “particular” which is omitted must be material to that “statement” with reference to the “form and context in which it is included”. It is not argued that the section would not apply to more than one statement.                                                             51 Graham, Notes of evidence, Vol. 4, pp 1819-1820; cross-examination p 1882. Sir Douglas could claim that his concern was allayed in that, at the next and critical meeting of the Board on 19 December, the forecasts showed positive cash balances.

52 Supra n 12, [57] and [89].

53 As the sentence expresses the directors’ “confidence” that Lombard had the requisite cash resources and the directors were found as a matter of fact to be honest and genuine in their belief, this statement cannot be literally untrue.

54 [2012] NZHC 665 (CRI-2008-004-029179), at [212].

 

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It is to be acknowledged that the possibility a prospectus could be deemed untrue by reason of the omission of a particular rendering it misleading when read as a whole cannot be lightly dismissed. If it were otherwise, directors who kept the statements in a prospectus to a minimum would be at an advantage that Parliament could not have intended. It would be difficult to identify a particular statement as the statement that was to be deemed untrue as a result of the omission. But caution is required before dismissing such an interpretation entirely. Not only does the literal wording seem to contemplate a statement or statements but it is also possible that the legislature had good reason to link an omission to a specific statement or statements. Otherwise omissions, by their very nature, would be open-ended. In other words, the legislature could have recognised that without a specific statement or statements being identified it would be difficult to say what is or is not misleading. But even if s 55(a)(ii) can be interpreted so as to apply to all the statements in the prospectus relating to liquidity read as a whole, the subsection still needs to be applied with a measure of caution. It should not be sufficient to say, as the Court of Appeal has said, that the section dealing with liquidity risk conveys an untrue “impression”. Something more specific than an impression needs to be identified before it can be sensibly said that the document is misleading. What is omitted must be capable of giving the lie to what was actually said, even if the document is read as a whole. Some vague “impression” does not provide a sufficient foundation for a criminal offence. Finding that the company was in a particularly vulnerable state and that the identified risks were imminent does not take the specificity of the omitted particulars any further. The Court does not suggest that the amended prospectus should have said the company was in a “vulnerable state” or that the risks were “imminent”. Rather, these matters are apparently to be gleaned from the impression which arises from reading the prospectus as a whole. For the purpose of s 55(a)(ii), therefore, the generality of the respects in which the prospectus is to be deemed untrue remains. Importantly, as demonstrated below, the statutory defence becomes illusory unless a statement or statements in the prospectus which are rendered misleading by an omitted particular are identified with greater specificity than adopted by the Court of Appeal. 10 WHERE TO DRAW THE LINE Oliver Wendell Holmes dictum is well-known: “[W]here to draw the line… is the question in pretty much everything worth arguing in the law.”55 Unfortunately, the Court of Appeal did not seem to have this sage advice in mind when determining whether the amended prospectus was misleading. The question of what to include in a prospectus so that it is not misleading is very much a question of where to draw the line. Dobson J held that investors should not have to rely on the “judgement” of the directors. If the learned Judge intended to go so far as to say that the prospectus should, in effect, put the investors in the shoes of the directors, as appears to be the case, his finding is wholly impractical and lacking in commercial sense. The line can only be drawn at what is necessary to make the prospectus true as required by the statute. But the Court of Appeal was not persuaded that the Judge was wrong. Certainly, it accepted that the directors must

                                                            55 Irwin v Gavitt 268 U.S. 161, at 168 (1925).

 

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exercise a degree of judgement in deciding upon the wording of the offer documents and on the issue of materiality, but it maintained that the statutory obligation is clear; “...investors are entitled to make their own judgement on whether to invest on the basis that statements in the offer documents are true and not materially misleading”.56 No one can quibble with a formulation that recognises that an investor must exercise judgement in deciding whether or not to invest in the company and is entitled to rely on the prospectus as true and not misleading. The simplicity of this formulation, however, fails to face the difficulties which arise when the allegation is that the prospectus is deemed to be untrue because of what is omitted. The Court provides no guidance as to where it is appropriate to draw the line. While Dobson J relied on the judgment of some notional investor, the Court of Appeal substitutes the objective assessment of the Court, which is, of course, subjectively arrived at.57 Dobson J hazarded a statement as to what the amended prospectus should have said. His proposed statement reads:

Since mid-2007 [Lombard] has sought to build and maintain cash reserves to guard against the reduced investment and reinvestment rates likely to be caused by the loss of investor confidence in the finance company market. The company’s cash reserves reached a high of approximately $40 million in August 2007, and although the amounts fluctuate, the downward trend during December 2007 has been to around 22-18 per cent of that high point. The substantial majority of the cash reserves have been applied to repay maturing investments. The adequacy of [Lombard’s] cash resources is a source of concern to the directors. The company’s ability to meet its obligations to investors in the coming months depends upon receipt of loan repayments as forecast. The directors are dependent on the respective loan managers for protections as to the timing and amount of loan repayments. Since September 2007 there has been a substantial extent of over-estimation in the projected loan repayments, month by month. However, the directors continue to have confidence in the competence of the loan managers and provided there is a material improvement in the accuracy of their projections, [Lombard] will be able to continue meeting its obligations as they fall due.58

The difficulty arises in determining where to draw the line. For example, having referred to the loan payments as forecast, should the amended prospectus not also include the details of the loan repayments, when the repayments fell due, and the prospect of recovery in respect of those loans, including the stage the various developments had reached? Having referred to the loan managers, should the amended prospectus have explained the qualifications of the loan managers, highlighted the fact that they had been found reliable for the past five years, and the reasons why the directors considered they could be relied upon? Having referred to the projections of the loan managers, should the amended prospectus have explained the past record of the loan managers’ projections and how those projections had been scrutinised by the directors and found reliable? Having referred to the “substantial extent of over-estimation

                                                            56 Supra n 12, [67] and [167].  

57 Ibid, [167].

58 Supra n 9, [121]. 

 

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in the projected loan repayments”, should the amended prospectus not have explained why that was so, and why the directors accepted the projections? And so on. The Court of Appeal declined to formulate a statement as to what the amended prospectus should have said saying that it was not necessary for it to identify precisely how the particulars omitted should have been expressed. It was, the Court said, sufficient to identify the topics that ought to have been included. In making this claim the Court runs the risk of being accused of a “cop out”. If the Court knows enough about the company to be able to determine that the amended prospectus was misleading, it knows enough to be able to spell out in greater detail what should have been said. But spelling out with more precision what should have been said would give rise to the same problems that confronted Dobson J. Either the effort at greater detail would add little or nothing to the risk already highlighted in the amended prospectus, or it would have to be qualified by references to the various matters already traversed that led the directors to be confident the company would be able to meet its obligations as they fell due, or it would contain so much information as to be confusing, or it “would bury the ... [potential investors] in an avalanche of trivial information”.59 11 THE BANK LOCK-UP REVISITED The Court dealt with the effect of the unforeseen lock-up in February/March 2008 by the expedient of regarding it as neither necessary nor appropriate to analyse events after Christmas 2007. It accepted that the directors “could not have foreseen the major adverse events that effected all international economies in 2008 and led to the global financial crisis and what counsel described as the “bank lock-up”.60 But, it said, “storm clouds” had been clearly gathering in New Zealand during 2007 and had intensified as the year progressed. Lombard’s position in the last quarter of 2007, it added, was far from “business as usual”. The company, it claimed, was in an “extremely vulnerable state”.61 Referring to events overseas in 2008, it ruled that what might ultimately have caused Lombard’s collapse had “no relevance” to the case. The focus of the case, it reiterated, was on the truthfulness and materiality of the statements contained in the amended prospectus as at 24 December “in the light of what was known and could have been reasonable anticipated at the time”.62 It is difficult to know where to start in analysing this key paragraph. First, the question whether Lombard’s liquidity was adequate in December 2007 cannot be sensibly divorced from the bank lock-up in February/March 2008. Once it is accepted, as the Court accepted, that it could not have been foreseen in December 2007, the prospectus is to be judged on that basis. When it is judged on that basis it is difficult to see how the description of the company’s liquidity as at 24 December 2007 did not realistically describe the economic climate and the known risks which came with that climate.

                                                            59 Matrixx Initiatives Inc. v Siracusano 131 S. Ct. 1309 (2011) per Justice Sotomayer at 1318.

60 Supra n 12, [168].

61 Ibid.

62 Ibid, [169]. 

 

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Secondly, the Court nevertheless held that Lombard was in an “extremely vulnerable state”. But, it may be asked, if the bank lock-up is ignored for the moment, vulnerable to what? The company held $8-9 million in cash reserves. It received $33 million between September and December 2007 and was able to discharge $10 million in secured debenture stock in the next three months. The company was, as proved to be the case, vulnerable to the bank lock-up, but that event was not anticipated. Thirdly, the Court observes that Lombard’s position in the last quarter of 2007 was far from “business as usual”. When regard is had to the high standard of corporate governance instituted by the directors and the measures undertaken by them before and during that quarter, the implication that the directors carried on “business as usual” is lacking in judicial restraint. It is patently clear from the narrative given above, and the Court’s own survey of the minutes of the Board during that quarter (although somewhat selective) that the directors did not regard Lombard’s position as “business as usual”. Nothing is gained by the use of injudicious language. Finally, the Court’s rejection of the bank lock-up as a material factor is undermined by its acknowledgment that the truthfulness and materiality of the statements contained in the prospectus as at 24 December 2007 had to be determined “in the light of what was known or could have been reasonably anticipated at the time” (emphasis added).63 It is not in dispute that the bank lock-up and subsequent global financial collapse were not anticipated in December 2007. Neither the Reserve Bank of New Zealand, the Federal Reserve of the United States of America, the Bank of England, governments around the world supported by vast bureaucracies, nor all but a few economists, predicted the events of 2008. What, then, could have been reasonably anticipated by the directors as at December 2007?64 The conclusion is inescapable. A finding that Lombard was “extremely vulnerable” as at December 2007 without reference to the bank lock-up in February 2008 is unsustainable, particularly when advanced to support a claim that the charges against the directors have been proved beyond reasonable doubt. 12 THE PEDEN SCHEDULE Considerable contention and controversy surrounds a document which came to be known as “the Peden Schedule”. Relying on this schedule, Dobson J proceeded to find the directors guilty on the basis that, on a cumulative basis, the repayments over the four months from September to December was 46 per cent of the amounts projected by the loan managers. The schedule is open to severe criticism both procedurally and substantively. 12.1 The Peden schedule - fairness The Peden Schedule was admitted - or not admitted - into evidence in a strange way, especially bearing in mind that this was a criminal trial.                                                             63 Supra n 12, [???].

64 The word “vulnerability” does appear in the Board minutes of 28 November 2007. But this was in the context of a “worst case” projection showing no repayments of loans at all. It was noted that the company was in a “very vulnerable position if loan payments were not received”. But it is a quantum leap to jump from this statement to the conclusion that the company was “extremely vulnerable” when payments of $33 million were received in December 2007 and projections confirmed further receipts were projected for 2008.  

 

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The Crown had closed its case. Sir Douglas Graham was the first witness for the defence. Counsel for the Crown put the Peden schedule to Sir Douglas in cross-examination. The schedule had not previously been produced and there had been no prior disclosure of it to counsel for the defence. Sir Douglas at once complained that he had not seen it and had not had the opportunity to consider it. As the schedule is a complex analytical calculation, his protest was understandable. But Dobson J did not rule on the admissibility of the schedule at that stage. Counsel for the Crown offered to recall Ms Peden to formally produce the document. Either then or later defence counsel said he would oppose her being recalled. At some stage he also indicated he would call evidence which would be critical of the schedule. On this unsatisfactory basis the cross-examination of Sir Douglas continued, including cross-examination on the schedule. Later in the trial, in the course of the cross-examination by the Crown of Mr Beddie, Lombard’s Chief Financial Officer, defence counsel sought to put the schedule to the witness. Mr Beddie acknowledged that he had been shown the document before giving evidence but expressed a strong reluctance to answer questions about it because he was not satisfied it was accurate. He rejected a “mathematical formula”.65 Defence counsel then formally objected to the questions being pursued. Dobson J upheld the objection “in the circumstances as they were at the time”.66 In the discussion that ensued, the Judge referred to the “prospect” that counsel for the Crown would apply to recall Ms Peden and Mr Beddie. Neither application was ever made. As foreshadowed, evidence was called by the defence which was critical of the Peden schedule. Mr Gray, an internal accountant, gave detailed evidence seeking to refute both the methodology and substance of the schedule. His evidence on the schedule alone covers some 39 pages of the transcript.67 In his judgment, Dobson J stated that the schedule had been “produced” before the Crown closed its case.68 The learned Judge was wrong on both counts. The document had never been “produced” and it had not been tendered or referred to until after the close of the Crown case. Indeed, it would seem incontrovertible that this critical schedule was never “admitted” in evidence at all. Its status remains obscure. Alarmingly in a criminal trial, the contentious document then became the key piece of evidence in the trial Judge’s reasoning. In holding that repayments were 46 per cent less than the recoveries forecast in the four months leading up to December 2007, Dobson J did not refer to the lengthy and detailed evidence of Mr Gray seeking to refute the Peden schedule, other than on an inconsequential point. To an informed reader it must appear as if the Judge had forgotten the evidence that had been called to refute the validity of the schedule. As the Judge chose to make the percentage of 46 per cent the basis of his reasoning the criticisms made by Mr Gray should, at the very least, have been recounted and addressed.

                                                            65 Beddie, Notes of evidence, Vol. 5, pp2475-2476.

66 Ruling No. 1 of Dobson J, dated 24 November 2011.

67 Gray, Notes of evidence, Vol. 5, pp2673-2712.

68 Supra n 12, [99].  

 

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It is true that counsel from time to time hand up documents to the trial judge as a summary of the evidence which they wish to incorporate in their submission, although this practice is generally restricted to civil trials. Such documents do not purport to add anything to the evidence and judges are generally meticulous in ensuring that the documents do not do so. Evidence must come from the witness box, not counsel. The summary depends for its credibility, therefore, on not introducing additional evidence. But as the Peden calculation is a complex analytical calculation purporting to be based on expert evidence it would be unfair to regard it as anything but evidence. It clearly needed to be subjected to cross-examination. The schedule, for example, purports to show that the sum of $71 million was due in repayments between September and December 2007. But that figure does not appear once in some 4000 or more pages of evidence. It is not easy to work out from the evidence just what the correct figure should have been. The Crown opened its case on the basis that $49 million was due in repayments and the only expert witness called by the Crown, Mr Cable, confirmed that figure.69 One thing is certain, the correct figure was not $71 million and the correct percentage was not 46 per cent. The Court of Appeal’s reaction to the “production” of the Peden schedule is remarkably benign. The Court initially describes the schedule as an analysis by Ms Peden “of data drawn from material already in evidence”.70 As already mentioned, that claim is suspect. The Court then proceeds to summarise the schedule’s erratic course to its acceptance by the trial Judge and his reliance upon it in his judgment. The Court of Appeal confirmed that the schedule was critical in Dobson J’s reasoning. It said; “It was on the basis of Ms Peden’s Schedule that the Judge found that, cumulatively, the repayments over this period were only 46% of the amounts projected”.71 The Court’s summary of the process by which the schedule became the critical document in the conviction of the directors is heavily weighted against the defence. Reference is made to defence counsel’s decision to refuse the offer to recall Ms Peden, his advice to Crown counsel that he would resist any application to recall her during the cross-examination of Mr Beddie,72 and the fact that some eight days after Mr Beddie’s evidence had been completed, the defence chose to call Mr Gray to give evidence that was critical of the “conclusions” reached by Ms Peden in the schedule.73 The Court concluded there was no risk of a miscarriage of justice as the defence had not taken up the Crown’s offer to recall Ms Peden and were “not disadvantaged by the course of events since there was an opportunity to comment on the schedule”. “The schedule had”, it added, “been placed in the Crown’s bundle of documents without objection”.74 No criticism of defence counsel is intended. One should be hesitant to criticise the decisions of counsel when, after the event, the twists and turns in a long trial cannot be recaptured. But                                                             69 Cable, Notes of evidence, Vol. 3, p 1484, in respect of selected large exposures during September to December 2007. Mr Cable is a partner in Deloitte. He did not carry out an investigation himself but restricted his evidence to Ms Peden’s material.

70 Supra n 12, 109].

71 Ibid, [113].

72 Ibid, [110].

73 Ibid, [111].

74 Ibid, [112]. 

 

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no such latitude need be extended to the judges. The ultimate responsibility for ensuring a trial is fair rests squarely on the court. The Court of Appeal’s reaction is that of a court unwilling to condone a technical objection to the admissibility of a piece of evidence.75 But this case is far removed from such a case. The fact of the matter is that this sorry saga should not have happened. Indeed, the Court of Appeal could have chosen to describe it as a shambles. Dobson J should not have allowed the status of the schedule to be left up in the air when it was tendered to Sir Douglas in the course of cross-examination after the Crown had closed its case. Sir Douglas should not have been cross-examined on the schedule when it had not been disclosed to the defence and never seen by Sir Douglas before it was put to him. At the very least, cross-examination on the schedule should have been deferred until Sir Douglas had the opportunity to study it, obtain expert advice on it, and discuss it with counsel. Nor should the cross-examination have been permitted to continue until he had the opportunity to do so. When the status of the schedule again became an issue during Crown counsel’s cross-examination of Mr Beddie, Dobson J was amiss not to give a more definitive ruling on the admissibility or status of the document before the defence evidence proceeded any further. It was also unfortunate, once it became apparent that Ms Peden was not being recalled to validate her calculation and that Mr Beddie was not being recalled for further cross-examination, that the Judge did not revisit the status of the schedule. Certainly, when the defence called Mr Gray and he gave evidence critical of the schedule, the Judge might have intervened to clarify the status of the schedule or, at least, ascertain counsels’ understanding of the position. At some point it would have been prudent for the Judge to point out to Crown counsel that Ms Peden had not been cross-examined on the schedule and that this omission would necessarily bear on the probative value the Crown might want to persuade the Court to place upon it. Rather than reacting benignly, the Court of Appeal should have appreciated that the issue could not be dispensed with as if it were a question of admissibility. The procedural parody should not have happened, but it did happen, and it was incumbent on the Court to determine whether it was prejudicial and unfair to the directors. Had this question been asked it is difficult to think the Court would have been so sanguine about such a procedural charade occurring in the context of a criminal trial. Can it, for example, be seriously suggested that, having regard to the criticisms that can be levelled against the schedule, the outcome would have been the same if Ms Peden had been cross-examined? The fact that, for whatever reason, Ms Peden was not recalled does not mean that the schedule thereby obtained the probative force of a document that has been the subject of prior disclosure and cross-examination. Further, can it be said with any confidence that the outcome would have been the same if Sir Douglas had been given the opportunity to see the schedule before being cross-examined, or if the cross-examination had been deferred until he had the opportunity to see it so that he would have been in a position to criticise it as part of his evidence, or if the schedule had been clearly ruled inadmissible when counsel took objection to it, or if the Judge had revisited the issue when it became apparent that the Crown was not going to recall Ms Peden or Mr Beddie, or if the schedule had not assumed the critical province it did in Dobson J’s reasoning, or if he had noted that the schedule contained figures that had not been mentioned in evidence, or if he had noted and addressed the formidable criticisms of the schedule in the

                                                            75 The author would be hypocritical not to admit an aversion to technical objections.

 

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evidence of Mr Gray? The prejudice is self-evident.76 Suffice to say that it would be a strange twist to the criminal law if such a series of procedural mishaps leading to the conviction of honest men could be reconciled with our accepted notions of fairness and a fair trial. Bearing in mind the dictates of criminal justice, it was therefore incumbent on the Court of Appeal to decline to place any reliance upon the Peden Schedule. But there is the rub. Once the schedule is set to one side, the “trend” or “pattern” of which the Court held the Peden schedule is “illustrative” is difficult to pinpoint in the evidence. For example, contrary to the Peden schedule which claimed that no cash flow projections had been included in the Board papers for the Board meeting on 28 November, a cash flow forecast was included which anticipated receipts of $17,096 million for that month. In fact, $13,655 was received. This figure represented 80 per cent of what had been forecast. 12.2 The Peden schedule – substantive flaws Controversy relating to the Peden schedule is not restricted to the “procedure” by which it came to assume such a dominant part in the outcome of the prosecution. As a matter of substance it would appear to be a flawed calculation. Certainly, the criticisms levelled against it are formidable and, to the extent that Dobson J and the Court of Appeal rely upon it, must diminish the validity of their judgments. First, the methodology adopted by Ms Peden does not reflect practice in the industry. The Court of Appeal accepted that the schedule was prepared with hindsight and was not the sort of detailed analysis that the directors could have been expected to undertake before issuing the amended prospectus.77 But the Court does not follow through on that perception. Taking a global and cumulative approach to the forecast departs from the reality of what is required. Each loan needs to be considered in its own right. Consideration needs to be given to the situation of the borrower and the progress of the development at the time. Any specific problem, such as the completion of sales’ contracts or delays in local authority approvals, needs to be addressed. For example, if the sales of properties in a development are delayed because the code of compliance is held up, but the code of compliance is reliably expected in the following few weeks, it is the fact that the sales will then proceed that is significant in determining the adequacy of the company’s liquidity. Each delay needs to be examined to ascertain whether it will continue and whether the cause of the delay has been identified and satisfactorily addressed. If the progress is not satisfactory the loan will not be rolled over. Questions of this kind were, of course, the questions the loan managers undertook and the questions the Large Loans Committee, and then the Board, pressed in monitoring the explanations given. In the result, an assessment of the recoverability of a loan was more likely to be answered by the discrete examination of each of the loans rather than by relying upon some “trend” or “pattern” arising out of an artificial analysis which has no recognition in the industry. At the very least, a calculation based on past perceived “trends” or “patterns” is incomplete without an examination of each loan and consideration of the facts specific to each loan. Recoverability is loan-specific.                                                             76 It is safe to speculate that a murderer, rapist or robber would walk free (or certainly get a new trial) if he or she could show anything like this lapse in criminal justice. Even the proverbial dog would escape the noose.

77 Supra n 12, [159].

 

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Secondly, the figure given in the schedule for cumulative forecast repayments contained what was called “double ups”. Simply put, if a forecast repayment is not repaid in one month the forecast is carried forward to the next month, but this does not increase the amount outstanding. In other words, the repayments expected in successive forecasts were doubled up. For the three month period between September and December in 2007 the figure for cumulative forecast repayments, according to Mr Gray, contained double ups of some $19.01 million.78 Dobson J appeared to understand this mistake when Mr Gray was giving evidence.79 Oddly, he did not return to note the point in his judgment even though the double ups undermine his conclusion that repayments over those months were 46 per cent of the amounts projected. The Court of Appeal neither owned nor disowned the argument that the Peden Schedule was faulty because of these double ups, but purported to adopt the Crown’s approach and leave to one side the cumulative figures and simply work from a comparison of the average monthly forecasts versus the actual payments received. It then claimed that Mr Gray accepted in cross-examination that the forecast loan cash flows compared with the payments actually received showed that the average received for the months of September to November was 40 per cent. The Court then observes that the average across the whole of the period to the end of March 2008 “was 46 per cent”.80 To arrive at this figure the Court includes forecasts and recoveries to the end of March 2008 when the bank lock-up had taken its toll. Dobson J’s figure of 46 per cent, of course, was to the end of December 2007. Most significantly, however, the Court acknowledges that, when being cross-examined, Mr Gray refused to accept that the figures contained in the schedule were correct.81 In addition, it is probable that focusing on percentages calculated in hindsight led the Court to perceive the company’s position as extremely vulnerable and the risks as imminent and to divert it from the question whether the directors, with full knowledge of the cash balance and the position of each unimpaired loan, had reasonable grounds to believe that the amended prospectus was true. The Court did not purport to independently ascertain that the figures were correct. Had it done so, the Court would have discovered that the Peden schedule used the Ferrier Hodgson forecasts of loan repayments for September to October, which matched the company’s internal forecasts, but then adopted the company’s updated forecasts through to March 2008. The figure of $71 million is arrived at on this basis. But a much lower figure is obtained if the Ferrier Hodgson forecasts only are used. Thirdly, the methodology on which the schedule is based is highly sensitive to the number of forecasts used and the size of the repayments due. The greater the number of forecasts the greater will be the cumulative deficit of repayments in relation to those forecasts. Similarly, a forecast relating to one large loan will inflate the percentage figures.82 If a significant expected payment is not received as forecast its non-repayment will distort the accuracy of                                                             78 Gray, Notes of evidence, Vol. 5 p 2689, referring to a document produced at p 2704. 

79 Gray, Notes of evidence, Vol. 5, p 2701/1-11.

80 Supra n 12, [157].

81 Ibid. 

82 In the same way as Bill Gates would distort the average wage of those gathered in a downtown bar if he were to stroll into the bar.

 

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the resulting percentage even though a large number of smaller repayments may be received as forecast. The Court of Appeal concluded that, despite the “possibility of some inaccuracies”, the analysis was “illustrative” of the extent to which loan repayments were not being met as forecast, notwithstanding the close monitoring and frequent adjustments of the forecast to take into account changing circumstances as they arose. But questions need to be asked. If a calculation is flawed is it not likely that what it purports to “illustrate” will also be flawed? Is it enough for the Court to simply recite the main criticisms made by Mr Gray without comment or making any enquiry as to their validity? If that enquiry is not carried out, and a flawed schedule is held to be “illustrative” of the disparity between forecasts and repayments, is there not a real a danger that the Court will be led to adopt a distorted perception of the company’s financial position? It follows that, if the Court’s perception of the company’s financial position is distorted its perception of what should have been included in the amended prospectus will also be distorted or, at least, unreliable. When so much turned on a schedule, the status of which had never been determined, which had not been subject to cross-examination, which had not been disclosed to the defence before the Crown case had closed, which took the witness to whom it was put in cross-examination by surprise, which was never “produced” in evidence, and which then became the key “evidence” leading to the conviction of the directors, much more could have been expected from the Court of Appeal. 13 AN ILLOGICAL OMISSION The Court’s reasoning in finding that the amended prospectus was misleading because it omitted reference to the deterioration in the company’s cash reserves is suspect in the absence of a finding that the reserves of $8-9 million in December 2007 were inadequate.83 Dobson J did not address the question whether the cash reserves in December 2007 were inadequate in the circumstances at the time. Nor does the Court of Appeal seek to address that question. Yet, the finding that the deterioration in the cash reserves and the other aspects the Courts’ hold were fatal omissions from the amended prospectus must logically presuppose that the reserves were inadequate. The deterioration is relative. For example, if the directors had built the cash reserves up to $80 million instead of $40 million in August 2007, the same deterioration, the same downward trend, the same pattern of delays in repayments, and the same discrepancies between projections and receipts would have resulted in cash reserves of $49 million in December. It may be doubted that the Crown would have asserted, or that the Court then would have held, that the liquidity was inadequate or that the amended prospectus was misleading because of those omissions. In the result, the question whether the amended prospectus was misleading is assessed on the basis of a premise which was never addressed, never proved, and never corrected. Such an

                                                            83 Mt Dinsdale, the external auditor, did not suggest that the $8-9 million was inadequate. Indeed, none of the witnesses suggested there was crisis in cash. It may also be noted that, although Dobson J said that the adequacy of the company’s cash resources was a matter of concern to the directors in his paragraphs as to what should have been said in the amended prospectus quoted above, he did not at any point make a finding that the cash reserves were not adequate as at December 2007.  

 

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omission does not sit comfortably in the context of a criminal trial where the charge has to be proven beyond reasonable doubt. 13 IMPAIRMENT AND LIQUIDITY

The Crown’s key allegation that Lombard’s loans were impaired was rejected by Dobson J with one exception which he regarded as immaterial. This finding of fact was not at issue in the Court of Appeal. Neither Dobson J nor the Court of Appeal, however, appears to have appreciated the true significance of the fact that Lombard’s loans were not impaired. Dobson J was not satisfied that as, at December 2007; “... there was any sufficient pattern of delayed sales or drop off in activity affecting developments of the type over which [Lombard] has security, for it to require the recognition of impairment effecting all, or a majority, of the major loans”.84 The Court of Appeal accepted the Judge’s finding that there was no adverse impairment of Lombard’s loans and acknowledged that the issue was relevant to liquidity. It stated, however, that it did not regard the fact that loans might ultimately be recoverable as a “determinative factor”.85 “The concern”, it stated for the purposes of liquidity, “was with the timing of repayments”.86 The use of the phrase, “determinative factor” is troubling. There is no suggestion that the fact no loans were impaired is “determinative” or that it was a “determinative factor”. The Court’s finding either misses or obscures this point. No one would deny that a company may have a liquidity problem notwithstanding that no loans are impaired. Such an observation is trite. The extent of the liquidity problem, if there is a problem, however, cannot sensibly be divorced from the recoverability of the loans. The cash reserves cover interest payments and repayment obligations and provide a buffer against loan failure. Hence, where a loan is impaired, or in danger of being impaired, the amount of the cash reserves held needs to be greater than in the case of a company where no loans are impaired or no impairment is anticipated. The fact the company’s loans were not impaired and therefore ultimately recoverable is directly relevant to the question of liquidity. 15 THE DIRECTORS’ OBLIGATION TO EXISTING INVESTORS As recited above, the great bulk of investments in Lombard were the investments of existing investors. In owing a duty to the company the directors owed a duty to these investors. Indeed, it is a statutory duty.87 Both Dobson J and the Court of Appeal refer to this duty but misconceive the strength of the point which arises out of it. Dobson J declined to take the interests of existing investors, whether the holders of debt securities or shareholders, into account in determining the

                                                            84 Supra n 9, [178].  

85 Supra n 12, [74] and [76]. It is also a question the Court might have thought relevant to its findings that Lombard was “vulnerable” and the “imminence” of the risk of collapse.

86 Ibid, [76]. 

87 Sections 131 and 137, Companies Act 1923.

 

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reasonableness of the views formed by the directors.88 The Court of Appeal followed suit, other than, contrary to Dobson J, it correctly addressed the question in the context of the accuracy of the amended prospectus. The Court stated the obvious; the obligation to issue offer documents that are true and not misleading overrides the duty investors owe to the company where these duties conflict.89 It added, “... if the directors cannot be satisfied that the statements contained in the offer documents are true and not misleading by omission, the offer should not be made irrespective of the consequences that might then flow”.90 There is, of course, no question but that s 58(1) prevails. Any perceived duty to existing investors cannot be permitted to influence the content of the offer documents in such a way as to diminish the directors’ obligation under the subsection. Rather, the point is that the directors would be in breach of their duty to the existing investors if a prospectus misstated, overstated or exaggerated any perceived risk. It is not a question of a “conflict” as Dobson J and the Court of Appeal saw it, but rather a matter of conveying the true financial position of the company so as to discharge the duty under s 58(1) and the duty to existing investors not to misstate or overstate any risk to their detriment. The offer documents must be true and not misleading for the purpose of s 58(1) but not untrue or misleading by reason of any misstatement or overstatement for the purpose of the directors’ duty to existing investors The point can be illustrated by postulating the situation where the prospectus overstates the risk involved and the company collapses as a result. At once the existing investors could claim that the directors were in breach of their duty to the company in overstating the true position and thus causing them the loss of their savings. The questions before the courts would be whether the prospectus overstated the risk involved. Their advocate would urge that the directors had been unduly alarmist. This argument confirms just how difficult it is to know where to draw the line when the issue turns on omitted particulars. When does a statement become a misstatement or an overstatement? The directors could honestly believe that the Court of Appeal’s specification of the matters that should not have been omitted, and the language used in formulating those matters, would be to misstate the true financial position of the company and, in the circumstances existing as at December 2007, overstate the risk to investors. Because the mere assertion that s 58(1) must prevail is trite and the Court of Appeal did not exhibit an appreciation of the respective obligations of the directors it would, perhaps, be unsafe not to prefer the directors’ perception that, although there had been a decrease in liquidity, it remained sufficient to meet interest and redemption payments as they fell due. The Court’s lack of appreciation of the difficulty facing directors in ensuring that the statements in a prospectus relating to risk are true, but at the same time not untrue by reason of being misstatements or overstatements, is troubling. Practising directors will be acutely aware of the difficulty. When the courts fail to perceive how critical an issue is, there is a danger that judges will be seen to be commercially unrealistic and magisterially judgemental.

                                                            88 Supra n 9, [136]-[137]. Dobson J made this finding in the context of whether the directors had reasonable grounds to believe the prospectus true, which is the wrong context. It is relevant to where to draw the line as to what should or should not be included in the prospectus.

89 Supra n 12, [172].

90 Ibid. 

 

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16 THE STATUTORY DEFENCE The complexity of applying the defence that the directors had reasonable grounds to believe the amended prospectus was true is clearly apparent in the case where the untruth is alleged to arise from omitted particulars. If a positive statement in a prospectus is found to be untrue, the statutory defence will apply if the directors can explain why they believed the statement to be true and the explanation is reasonable. This simplicity is lacking in this case. In both the judgments of Dobson J and the Court of Appeal the reasons why the omitted particulars in the amended prospectus are said to be misleading become the reasons why the directors did not have reasonable grounds to believe the prospectus was true. The directors were effectively deprived of the benefit of the statutory defence. A moment’s reflection by the Courts would have been sufficient to confirm that this could not have been Parliament’s intent. Parliament cannot have intended to provide a defence for directors who have reasonable grounds to believe a positive statement in a prospectus is true and yet effectively deny directors that defence when the prospectus is held to be misleading by reason of omitted particulars. While acknowledging some infelicities in his language, the Court upheld Dobson J’s reasoning; the directors’ belief that the amended prospectus was true without the omitted information was not a belief based on objectively reasonable grounds.91 The Court of Appeal refers to the factors that led it to conclude the amended prospectus was misleading and repeats the findings of the trial Judge that it was not reasonable for the directors to conclude that monitoring the accuracy of loan repayment projections was a matter of detail on which investors would trust the judgement of the directors.92 But it is not a question whether it was a matter requiring investors to trust the directors’ judgement. Rather, it is a question of where to draw the line and that requires the directors to exercise a decision - or judgement - as to where to draw that line. This does not mean that investors must trust the judgement of the directors on a matter that should be included in the prospectus to avoid it being untrue or misleading. The Court can decide that the directors have drawn the line in the wrong place, but it can reach that decision without purporting to refute an argument that has the substance of a straw man. In short, the Court of Appeal erred in two essential respects in its approach to the statutory defence. First, it failed to keep the questions in issue separate; first, was the amended prospectus misleading by reason of omitted particulars and, secondly, if it was, did the directors believe, and have reasonable grounds to believe, the prospectus was true notwithstanding those omissions. Both Dobson J and the Court of Appeal conflated the two questions. Secondly, the Court should have interpreted and applied s 58(2) so as to give effect to Parliament’s intent to provide honest directors with a defence when they can objectively demonstrate reasonable grounds for believing that the prospectus was true. In this respect, the Court set the threshold for the application of the defence too high. The Court of Appeal made no bones about conflating the two questions. It states that there was a substantial evidential foundation for Dobson J to conclude that the directors did not have reasonable grounds for believing the amended prospectus true and declined to rehearse in detail its reasons. “It follows inevitably”, the Court continues, “from our discussion of the                                                             91 Ibid, [189] - [191].

92 Ibid, [189]. There does not appear to be any direct evidence that the directors regarded monitoring the accuracy of the projections as “a matter of detail”. Indeed, the evidence is overwhelmingly to the contrary.

 

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factual background at [25]-[53] of this judgment and our discussion of the reasons why there was a proper basis for the Judge to conclude that the statements in the amended prospectus were untrue by reason of omission.”93 At that point, the directors effectively lost the benefit of the statutory defence. It is possible that this conflation of the two distinct questions led the Court of Appeal to endorse Dobson J’s approach and set the threshold for a finding that there were reasonable grounds too high. The imposition of strict liability in respect of s 58(1) is not to be imposed on s 58(2). Parliament clearly intended to mitigate the rigours of strict liability under s 58(1) with a defence that would exonerate directors who had reasonable grounds, objectively determined, to believe the truth of the offer documents. The argument is logically unassailable, however, that once the two questions are conflated the strict liability applicable under section 58(1) necessarily infects the defence under s 58(2). A more realistic threshold for the defence was open to the Court of Appeal in the legislature’s use of the word “reasonable” in the phrase “reasonable grounds to believe”. The Court did not have to agree with the grounds; it had only to find that they were “reasonable”. In other words, the word “reasonable” is open to an interpretation and application that would give the statutory defence a tenable meaning which would accord with Parliament’s intent. A number of points indicate that intent. First, there is the clear intention on Parliament’s part to mitigate the imposition of strict liability with a defence which would have real effect and not be submerged in the decision reached as to the truth of a prospectus under s 58(1), as already touched upon. Secondly, the extracts from Hansard quoted above confirm that the legislature did not intend s 58(1) to automatically apply to responsible and honest directors. Parliament’s objective is defeated if the phrase “reasonable grounds to believe” is virtually put beyond the reach of responsible and honest directors. Thirdly, Parliament can be assumed to have enacted s 58(2) having regard to the underlying principle of the criminal law referred to above. There is no sound reason why this policy consideration should not have influenced the Court’s interpretation of the statutory defence. Finally, the threshold as to whether directors have reasonable grounds to believe the prospectus true should have regard to the established principles of a directors responsibilities. In other words, Dobson J’s finding, upheld by the Court of Appeal, that the directors were guilty of a “material misjudgement” cannot preclude a finding that they had reasonable grounds to believe the amended prospectus was true . To hold otherwise, notwithstanding the omission of the particulars the Court considered important, would negate the statutory defence and smack of judicial indifference to Parliament’s intent. 17 REASONABLE GROUNDS Addressing the statutory defence discreetly and adopting a more realistic approach, the directors claim to have had reasonable grounds to believe the amended prospectus was true appears extremely strong. In the first place, regard must be had to the fact, acknowledged by the Court of Appeal, that the amended prospectus contains considerable detail; the nature of Lombard’s business; the

                                                            93 Ibid, [194].

 

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risks investors faced; measures taken by the company to manage those risks; the reduced levels of reinvestments being experienced; the fact sales of properties were delayed; the fact that, if Lombard failed to manage its liquidity, due to mismanagement of its own borrowings or matured loans not being repaid on time, there could be insufficient funds to repay investors; the risk that should the loss of liquidity be of a magnitude to cause Lombard to become insolvent, there could be insufficient funds to repay investors; the fact market confidence in the finance sector had decreased and might decrease further if there were further failures of other finance companies; the fact there had been a reduction in current loans and that a period of constrained liquidity would impact on the company’s future growth, and so on.94 The Court had to consider whether the directors had drawn the line between what was true of the company’s financial position and the risks to investors, on the one hand, and what would have been a misstatement or overstatement of the company’s financial position and risk, on the other. Secondly, the company operated in accordance with the tenets of good corporate governance. The whole purpose of good governance is to ensure a high standard of supervision and management in the operation of the company. It is not in dispute that this standard was achieved and it was reasonable for the directors to believe that this good governance would achieve its purpose and result in an amended prospectus that would properly inform investors of the company’s current position. Thirdly, the directors had reasonable grounds to believe that they had sufficient cash reserves to withstand the downturn in the market. The company still held cash reserves in line with its policy95 and, following extensive scrutiny, believed that certain major developments had been completed and were ready for sale, and that the loans would be repaid to the degree required in the New Year. The 12 month projection tabled at the December meeting of the Board confirmed some $116 million of repayments over the following year with positive rising cash balances each year. The directors’ belief was reinforced by the fact that the company’s demand exposure had been reduced and was continuing to be reduced. But the directors did not foresee the unprecedented bank lock-up in February/March 2008. They were not alone. Can it be plausibly suggested, for example, that the Governor of the Reserve Bank did not believe, or did not have reasonable grounds to believe, when he ended 2007 anxious but hoping that the “worst was now behind us”. Fourthly, there was a reasonable basis for the directors’ belief that their confidence in the advice of the loan managers was not misplaced. The loan managers’ explanations had been consistently sound in the past. Their excellent track record reflected their experience and expertise.96 Their explanations for the repayments which were delayed were examined closely and found to be sound. Indeed, it is to be noted that Dobson J did not find that the explanations provided by management were unreasonable and the Court of Appeal did not seek to reverse that finding. Nor did Ferrier Hodson find the forecasts unreasonable.97 The explanations of the loan managers were closely scrutinised by the Large Loans Committee established by the directors in mid-May 2007. The unchallenged evidence shows

                                                            94 Ibid, [141].

95 Dobson J expressly found that there had been no material breach of the company’s lending policies, at [259].

96 Supra n 9, [125].

97 Supra nn 40-43.

 

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that the explanations of the loan managers were subject to the equivalent of a grilling. Not only did they have to provide acceptable reasons for the delays but also had to demonstrate that the revised projections would be met.98 At Board meetings management were again questioned closely as to the reasons for any delays in anticipated payments and the reliability of projections as to repayments. Having regard to the fact no loans were impaired, the delays were perceived as being just that, delays, and not the forerunners of non-recoverability. Dobson J held that the directors did not attempt to independently vet the reasonableness of assessments made by the loan managers.99 The Court of Appeal seemingly endorsed this notion. It held that there was evidence from which the trial Judge could properly conclude that the directors could not reasonably rely on the executives’ advice and were obliged to take a much more “direct personal interest” in the company’s affairs than might have been a case in a more favourable market.100 It is difficult to reconcile this statement with what the directors actually did, as has been traversed in full above. They could not have taken a closer interest in the progress of the developments and the projections. If the suggestion is that, in order to take a “direct personal interest”, the directors should have personally inspected projects, personally visited building sites, personally approved valuations, personally vetted quantity surveyors’ reports, and the like, it is plainly ludicrous. In looking for an interest that was not just close but was “personal” on the part of the directors, the Court seems to have confused the respective roles of management and a board. It is no part of a directors’ responsibility to undertake the tasks of management.101 As stated by Heath J in the Nathans case; “Directors direct; managers manage. That is the essential difference between governance and management. Directors establish the policy or rules that are to be implemented by management and put the systems in place to ensure their instructions are carried out.”102 In the circumstances it is difficult to see what more the directors could have done without shedding their role and responsibilities as directors and assuming the tasks of management. Finally, a number of independent and professional bodies were familiar with the company’s financial position and apprised of the contents of the amended prospectus but either expressed no concern or expressly accepted that it represented a true statement of the company’s position and the risk to investors. The Court of Appeal dismissed this absence of concern or advice in abrupt terms. For example, the Court said that Mr Foley’s advice was a factor relevant to the existence of the reasonable grounds of belief but it could not have been “decisive” in the circumstances.103 Speaking of the professional legal advice which the directors received in these round terms does not convey the extent or nature of the advice involved in the preparation of the amended                                                             98 Notes of evidence, Vol. 6, pp 3324/15-27.

99 Supra n 9, [104] and [236] – [237].

100 Supra n 12, [197].

101 See also Preamble and s 138 of the Companies Act 1993 providing that directors may rely on management reports and professional advice given by competent people.

102 R v Moses HC Auckland CRI-2009-004-1388, 8 July 2011, at 74. See to the same effect, Dairy Containers Ltd v NZI Bank Ltd [1995] 2 NZLR, 30, per Thomas J at [79], approved by the Court of Appeal in Mason v Lewis [2006] 3 NZLR 225, at [115].  

103 Supra n 12, [197].

 

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prospectus. The prospectus which was replaced by the amended prospectus in December had been prepared by Phillips Fox.104 That company was asked to reassess and review the prospectus having regard to the financial conditions in November.105 The firm produced a draft amended prospectus in mid-November.106 The directors then instructed Mr Foley of Minter Ellison, an acknowledged expert in the area of prospectuses, to review the draft.107 He did so, and made a number of extensive changes and additions to the text of the draft.108 It was also sent to the Companies Office who discussed it with Mr Foley.109 Finally, it was sent to the Trustee for approval.110 The use of the word “decisive”, as with the word “determinative” in respect of the relationship between impairment and liquidity,111 is troubling to the logical mind. The advice of itself does not have to be “decisive”. Indeed, no one would pretend that the advice of Mr Foley or the other professional advisers could be, or had to be, “decisive”. Rather, the advice forms part of the matrix of facts which make up the reasonable grounds for the directors’ belief that the amended prospectus was a true document. Adverse advice would certainly have a bearing on the question whether the directors had reasonable grounds for their belief in the integrity of the amended prospectus. Positive advice may not carry the same weight, but it is nevertheless a factor in the objective assessment of whether reasonable grounds exist for the directors’ belief. It was simply not good enough for the Court to discount independent advice because it was not “decisive”. Another example is the affirmation of the Trustee, whose statutory obligation is to protect the interests of investors.112 The Trustee must be satisfied that the company is able to meet its interest and repayment obligations to existing investors and that there is nothing in the prospectus that is untrue or could be misleading to potential investors. In examining the evidence the Court would have been aware that the Trustee was kept fully informed as to the company’s financial position at all times. From time to time, the internal auditor, the Chief Executive officer and the Chief Financial Officer had discussions with a representative of the Trustee. The Trustee was certainly given a copy of the draft amended prospectus. It was far from being a passive recipient of information. When it expressed concerns those concerns were addressed. Again, therefore, it is unrealistic to dismiss the fact that the Trustee did not intervene to in respect of Lombard’s ability to pay its debts or about the truth of the offer documents as being of no avail to the directors.113

                                                            104 Foley, Notes of evidence, p 2962.

105 Ibid, pp 2961-2963, and Def. vol. 6/Tab 32.

106 Def. Vol. 6/Tab 32.

107 Ibid, p 2962.

108 Ibid, p 2973. 

109 Ibid, pp 2968 and 2973.

110 Def. Vol. 3/Tab 16, an approval process document of over 40 pages.

111 See, supra n 85.

112 See s 33(2) Securities Act 1978, part IV Securities Regulations 1983, Regulation 24, 5th Schedule No. 1.

113 Supra n 12, [196].

 

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Mr Dinsdale, the audit partner in KPMG, Lombard’s auditors, was called as a witness by the Crown. When specifically asked whether he had formed the view that the company was in a precarious position in late 2007, he said that he did not consider there was an imminent risk of the company collapsing. He acknowledged that there were challenges, but he was firm in his view that liquidity was not a problem.114 In this context, the Court of Appeal also endorsed Dobson J’s opinion that the duty under s 58 is “non-delegable”.115 Yet, again, this statement is trite. Of course, the statutory duty under s 58(1) rests squarely on the issuer of the offer documents and that statutory duty cannot be delegated to anyone else. The fact that this is so, however, does not mean that professional advice received in respect of the prospectus is to be given no weight in determining whether reasonable grounds exist for the directors’ belief. The duty, as such, is non-delegable but it would be absurd to suggest that professional advice is therefore of no consequence in determining whether the directors had reasonable grounds to believe offer documents are true. What the Court of Appeal has done in holding that the duty is “non-delegable” is to, in effect, transmit the strict liability of s 58(1) on to the statutory defence in s 58(2). 18 THE WISDOM OF HINDSIGHT Originally used to describe the backsight of a rifle, the word hindsight has become an abstract word meaning “wisdom after the event”.116 Both Dobson J and the Court of Appeal disavowed this wisdom.117 It is, of course, universally accepted that judges will guard against the use of hindsight, but it is puzzling that judges persist in claiming outright success in doing so. The human condition does not readily allow such detachment. Eliminating hindsight requires a degree of intellectual rigour which is probably seldom achieved. It is certainly open to question whether that rigour has been achieved in this case. To anyone reading the evidence or familiar with the facts it would seem apparent that the Court of Appeal has been influenced by the fact the company was trading through a difficult period at a time when “storm clouds were gathering” in 2007. Yet, those “storm clouds” were not so apparent to, among others, governments around the world, central banks in any number of countries, trading banks everywhere, most economists, and any number of financial commentators at the time. It is difficult to believe the finding that Lombard was “vulnerable” to imminent risk in December 2007 was a finding made without being conscious of the unprecedented bank lock-up in February 2008 and the resulting collapse of Lombard. Indeed, hindsight probably accounts for the difference between a description of the risk as described in the amended prospectus and the Court’s repeated description of the risk as “serious”.118 If hindsight were not a factor, it is difficult to see why many positive features of the directors’ position did not receive more favourable attention. Probably, and conversely, if the company had not gone into receivership in April 2008 the perception of the directors’ conduct would

                                                            114 Notes of evidence, Vol. 2, p 1138.

115 Supra n 12, [196].

116 Ed. R W Burchfield, The New Fowler’s Modern English Usage (Oxford University Press, revised ed., 1996). 

117 Supra n 9, [115]; C/A, [145].

118 Supra n 12, [89], [97], [161], [163], [170], [195], [211] and [246].

 

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have been much more positive and favourable. The extent to which it is neither positive nor favourable is certainly due in part to the wisdom of hindsight. 19 THE STING IN THE TAIL The Court of Appeal’s decision to find the sentences of Dobson J manifestly inadequate and impose sentences of home detention is a brutal sting. The Court said that the sentences needed to reflect the gravity of the offending. Regard had to be had to the substantial sum invested or reinvested “on the strength of the truths of the amended prospectus”.119 Although it accepted Dobson J’s characterisation of the directors’ culpability was a misjudgement, the Court was not prepared to overlook the Judge’s finding that the prospectus was misleading. It accepted the Crown’s submission that the Judge had placed too little weight on “the statutory purposes of denunciation and deterrence”. “What was important”, it said, “was the need to deter others from offending in a similar way.”120 It considered that the trial Judge did not sufficiently “focus on general deterrence in holding the offenders accountable”.121 The starting point, the Court continued, did not reflect the purpose of the Securities Act to protect the investing public through the timely disclosure of material information. Such disclosure is required to facilitate the raising of capital and promote confidence by the investing public in financial markets. Failure resulted in a lack of trust in this country’s financial institutions, damage to capital markets and the wider economy, and loss of funds invested by the public.122 Having regard to these factors, the Court concluded, the Judge should have adopted a starting point of imprisonment in the case of each of the directors. It argued that this starting point was required to give effect to the important principle of “consistency in sentencing”.123 The Court considered that the starting point should have been two years imprisonment for the three non-executive directors and two and a half years imprisonment for the executive director. It then adjusted the starting point to 18 months and two years respectively to give effect to the long established principle that a sentence should be adjusted by no more than the minimum extent necessary to remove the element of manifest inadequacy.124 The Court then proceeded to consider what discounts should be allowed for reparation, remorse and good character. It concluded that the appropriate deductions for Sir Douglas and Mr Bryant should total no more than 25 per cent and that the 40 per cent allowed by the trial Judge was “manifestly excessive”, and for Mr Jeffries it should total no more than 10 per cent.125 Dobson J had applied unspecified reductions to Mr Reeves for his ill health and family reasons and the Court accepted that the sentencing Judge was entitled to take those

                                                            119 Ibid, [245], although as noted above, under ten per cent of the losses were reinvested or invested after the issue of the amended prospectus.

120 Ibid, [248].

121 Ibid, [249] and [262].

122 Ibid, [249].

123 Ibid, [250].  

124 Ibid, [251].

125 Ibid, [258].

 

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factors into mitigation. Although accepting that the offending did not appear to have been particularly serious, the Court considered that some weight should have been given to an earlier conviction as an aggravating factor.126 The Court of Appeal’s reasoning is open to criticism on a number of grounds. First, the Court should not have ignored the fundamental principle of the common law. The directors were not found guilty of intentional or reckless or grossly negligent conduct. Referring to the sentencing in the Nathans Finance case, Professor Peter Watts has observed:

The Judge might be right in thinking that a stiff term of imprisonment would perform a deterrent function here. Indeed, it is ironic that people who are not criminally inclined in the orthodox sense may be more susceptible to the deterrent function of imprisonment than those who are corrupt. But, is not a rather upside down world when the law takes to terrorising the honest?127

The Court failed to think the issue through. If it is accepted, as the Court accepts, that the directors were honest and did not intend to commit a breach of s 58(1), what is the Court “denouncing” and “deterring”? The answer can only be that the Court is “denouncing” and “deterring” honest and unintentional conduct! That is a nonsense. The fact that s 58(1) is an offence of strict liability does not make any difference. Strict liability means that an accused cannot excuse him or herself because of a lack of intention. But it does not follow that honest and unintentional conduct must be “denounced” and “deterred” by a term of imprisonment or its equivalent in sentencing the accused. What may be appropriate where the conduct is intentional, reckless or grossly negligent is not necessarily appropriate where the conduct is honest and unintentional. Secondly, there is no sound reason why the “starting point” for an offence where the directors have been held to be honest and their conduct unintentional should be a term of imprisonment. The objectives of “denunciation” and “deterrence” do not of themselves necessitate imprisonment. Reparation and community service can also operate to denounce and deter. The courts will lose much of their ability to make the penalty fit the crime if sentences such as community work are perceived to be outside the purview of “denunciation” and “deterrence”. Indeed, a thoughtful judge could well conclude that there are some circumstances in which the conviction itself is a denunciation of the crime and serves to deter the crime.

Thirdly, the Court seems to have overlooked s 16 of the Sentencing Act 2002. Section 16 affirms the principle of keeping offenders in the community as far as is practicable and consonant with the safety of the community. It is no answer to say that having made the appropriate deductions for reparation, remorse and good character, the Court was able to arrive at a sentence of home detention rather than a prison term. Home detention also deprives the offender of his or her liberty. Fourthly, the Court of Appeal’s decision effectively means that the directors have not received any allowance for the fact they were honest. The Court has regard to the good character of three of the directors, but that consideration is expressly related to their “prior” or “previous” good character. Their honesty falls by the wayside.

                                                            126 Ibid, [259] – [260].

127 Company and Securities Bulletin (2012) CFLB, p 5.  

 

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An approach which has the effect of disregarding the honesty of the offenders is overtly mechanical. It is possible that, at least in part, the Sentencing Act 2002 is responsible for this approach. But it cannot be accepted that the Act dictates such a mechanical outcome.128 Nothing in the Act suggests that the judges’ approach has to be so slavish as to deprive offenders of a valid assessment of their culpability.129 Fifthly, it was unrealistic for the Court to disregard the fact that s 58 will shortly cease to exist. The Financial Markets Conduct Bill, which has bipartisan support, is presently before Parliament. Strict liability will be replaced by a range of offences which require knowledge, recklessness or, for some offences, negligence.130 As Adam Ross has pointedly said, “It will be small comfort to the Lombard directors that they had to be punished in order that others may be ‘deterred’ from activity that within weeks of the Court of Appeal’s judgment will not be a criminal offence at all”.131 Sixthly, the Court placed undue weight on the extent of the losses suffered by investors.132 It is, of course, a well-established principle that an offender must accept responsibility for the consequences of his or her offending. This principle makes perfect sense when the offence requires proof of mens rea. In such cases, the offender intended to offend and must therefore face the consequences, although unintended, of his or her intentional action. But, while still relevant, the principle lacks the same force when the offence is one of strict liability. In some cases, of course, the extent of the losses may on the facts warrant significant weight in sentencing. But for the most part, where directors are found guilty and their culpability does not involve dishonest, intentional or reckless conduct, the weight to be given to the losses of investors need not carry the ascendant weight conferred on it by the Court of Appeal. Seventhly, in a case such as Lombard’s, it seems inappropriate that the directors should be denied the benefit conferred on accused when they plead guilty. Accused who plead not guilty are not penalised for exercising the right to do so, but those that enter a plea of guilty generally obtain a significant reduction in their sentence. Such a regime may work well enough for the usual run of criminal offences. It is difficult to accept that this benefit should be effectively denied the accused in a case such as the present. The directors maintained that they could not reasonably be expected to have done more than they did. They certainly thought they had reasonable grounds to believe that the amended prospectus was true and not misleading. Their claims were supported by expert evidence. In such a case, the possible deduction for a plea of guilty is not a practicable inducement to enter that plea. The same can be said for a deduction for remorse. Directors in the position of the directors in this case will undoubtedly feel sympathy for the investors who have lost their investment. But it is difficult to see why honest men or women should express remorse for an offence

                                                            128 Paragraphs (e) and (f) of s 7(1) relating to the purposes of sentencing, for example, provide for the purposes of denunciation and deterrence but, as with the other seven purposes listed, are in the alternative. Similarly, the aggravating and mitigating factors specified in s 8 must only be taken into account “to the extent that they are applicable in the case”.

129 Indeed, s 8 which sets out the principles of sentencing requires the court to have regard to “the degree of culpability of the offender”.  

130 See, e.g., clauses 26D, 35(2), 40(1), 41B and 64A.

131 New Zealand Law Society, “Commercial Law Intensive”, June 3013, at p 17.

132 Supra n 12, [246], [249] and [262].

 

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they do not believe they committed. Again, it may be appropriate to expect remorse from a prisoner convicted of murder, rape, robbery or any other more orthodox crime. But in the case of the strict liability offence created in s 58(1), it seems unreasonable to expect directors who have been convicted under that subsection to accept that they were in fact guilty. In a commercial matter such as the present, which basically comes down to where to draw the line, it seems unrealistic to attribute the mantle of infallibility on the courts for sentencing purposes. Eighthly, seemingly overlooked in the Court’s approach is the impact of a conviction and the associated publicity on honest men with a public reputation and high profile. They will suffer humiliation, ignominy, dishonour, and opprobrium disproportionate to those who do not have that public reputation or high profile.

Finally, as indicated, the Court purported to reach its conclusion that the sentences imposed by Dobson J were manifestly inadequate in order to give “effect to the important principle of consistency in sentencing”.133 The Court had regard to the sentences imposed in other cases where convictions had been entered, most notably the Nathans Finance and Bridgecorp cases.134 While the Court is careful to note that the offending in those cases was much more serious than in the Lombard case, it seemed to fail to note that all the cases where imprisonment had been taken as a starting point involved dishonesty or gross negligence.135 The Court thought that the sentencing of Mr Bruce Davidson, who was the Chair of the Board of Bridgecorp, was “perhaps” the closest to the present case.136 After a plea of guilty, Mr Davidson was sentenced to 9 months home detention, 200 hours community work and reparation of $500,000. Mr Davidson himself had been found to be honest in his belief that statements in the prospectus were true. It was also held that his actions lacked any element of dishonesty or intentional wrongdoing. Mr Davidson received consideration for his plea of guilty, his distinguished career and his high reputation in the legal profession, his genuine remorse and his cooperation with authorities.137 In fact, the comparison with the present case cannot withstand a moment’s scrutiny. It is fully accepted that Mr Davidson was honest and had no intention of issuing an untrue prospectus. But he was the Chair of the Board of Bridgecorp whose governance and culpability was as different from the governance and culpability of Lombard as chalk is from cheese. The untrue statements in the offer documents in that case were either positive statements which were untrue, such as the claim the company had never defaulted or an omission in respect of a specific particular such as related party lending. In pleading guilty Mr Davidson necessarily accepted responsibility for not being as active as he might have been in supervising the conduct of a management that was acting dishonestly. Again, it can be suggested that a different perspective is required in respect of a complex commercial matter, such as the present case, than the more orthodox criminal cases where a comparison may make more sense. In this case, the comparison with Mr Davidson is forced.

                                                            133 Ibid, [250].

134 R v Davidson HC Auckland CRI-2008-004-29179, 7 October 2011.

135 Supra n 12, [233]-[244].

136 Although the Court was again careful to note that there were distinguishing features from the present case.

137 Supra n 12, [240].  

 

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The irony is that, in imposing a sentence of six months home detention, along with community work and, in the case of two directors, reparation, the Court’s sentence will appear to those who are familiar with the facts of both cases as being markedly inconsistent, the one with the other. 20 CONCLUDING REMARKS As at the time of writing the directors have applied for leave to appeal to the Supreme Court against both their convictions and the increased sentences imposed by the Court of Appeal. It would be inappropriate to seek to anticipate the outcome, and it is unnecessary to do so. Injustice is intolerable and commands a pressing rebuke. Our system of justice is the best that we can aspire to as mere humans. For the most part judges will get it right and their judgments will be well-reasoned and persuasive. But there will be cases which do not meet this norm. This article demonstrates that the conviction and criminalisation of the directors of Lombard is one of them. It is, as many readers will agree, a miscarriage of justice and will remain so whatever the outcome of any further proceedings. Why this miscarriage has occurred can only be a matter of speculation. But it would be surprising if it did not have something to do with the “syndrome” referred to at the outset, that is, if a finance company fails someone must be held accountable - someone must pay. While the article is critical of both the judgments of Dobson J and the Court of Appeal, it may well be that the problem is systemic and that, by virtue of our size and closeness, honest directors of finance companies whose alleged misconduct was unintentional and who had reasonable grounds to believe the prospectus they issued was true will not be accorded the same high procedural and substantive criminal justice that is guaranteed to more orthodox criminals every court day of the week. If the problem is systemic the wisdom of Parliaments’ proposal to repeal s 58 is patent. The directors of Lombard can feel aggrieved. They managed a company which practiced the best precepts of corporate governance; they had nothing to do with such practices as related party lending; they employed high quality staff; its loan managers adopted a micro-management approach to supervising the completion of developments; they engaged only Tier 1 professional advisers; they were fully alert to the fact they were entering a period of straightened times and built up the company’s cash reserves as a “buffer” against the possibility of borrowers defaulting; they instituted a strict regime for the monitoring of loans; cash flow projections were completed on a conservative basis and closely scrutinised with the directors insisting upon explanations that confirmed that, while a repayment might be delayed, it would be recoverable; they had no material impaired loans; notwithstanding their acknowledged concern, as at December 2007, the company held cash reserves that approximated the level of liquidity the directors maintained as a matter of policy and which was sufficient to fund repayments to investors when due; they decided to issue an amended prospectus in December 2007 so that investors would be better informed; they were fully cognisant of their statutory obligation to existing investors not to misstate or overstate the financial position of the company and the risks of investment; the amended prospectus was prepared and approved by highly competent professional advisers; and they honestly believed the amended prospectus was true and not misleading and that they had reasonable grounds for believing it was true and not misleading.

 

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Notwithstanding their efforts and the measures taken to counter the period of constrained liquidity in 2007, the company was brought to its knees by an external event, the bank lock-up in February/March 2008, which was unforeseen and over which they had no control. Yet, they found themselves convicted of an offence under s 58(1) and denied a finding that they had reasonable grounds for believing that the amended prospectus was true. Not only are the convictions upheld on appeal in a judgment which is less than satisfactory, but their sentences are held to be manifestly inadequate and increased to include home detention. The conclusion is inescapable, the directors have suffered a grievous miscarriage of justice. But the damage is not limited to the directors. A miscarriage of justice pierces the very heart of our system of justice and diminishes the virtue of the community which that system serves. Disclosure: Following the decision of Dobson J in the High Court, the author has proffered advice to Sir Douglas Graham and the other directors on an unpaid basis.

 

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