DUFFY, Dr Michael, Private capacity [by video link]

Committee met at 09 :31

CHAIR ( Senator Chisholm ): I declare open this hearing of the Senate Economics References Committee inquiry into the Treasury Laws Amendment (2021 Measures No. 1) Bill. The Senate referred this inquiry to the committee on 16 March 2021 for report by 30 June 2021. The committee has received 14 submissions to this inquiry, together with 26 submissions to the previous Senate Economics Legislation Committee inquiry, all of which are available on the committee's website.

As this is a public hearing, a Hansard transcript of proceedings is being made. However, the committee may determine or agree to a request to have evidence heard in camera. Information on procedural rules governing public hearings and claims of public interest immunity has been provided to witnesses and is available from the secretariat. I would like to advise witnesses that answers to questions on notice should be sent to the secretariat by 5.30 pm on Wednesday, 16 June 2021.

I now welcome Dr Michael Duffy. Thank you for appearing before the committee today. We have Senator Brockman online, and we also have Senator Walsh. Dr Duffy, I now invite you to make a brief opening statement, should you wish to do so.

Dr Duffy : I thank honourable senators for the invitation to submit and for the opportunity to appear today on this important issue. Senators have my detailed submission. I also circulated an opening statement last night. In summary, essentially, my focus is on corporations as defendants in shareholder class actions, so my focus is on the continuous disclosure and the misleading and deceptive conduct changes, with a focus on the effect on the corporations and on the investors and plaintiffs in relation to those.

As I hope my submission makes clear, and as my draft opening statement makes clear, I have come to a slightly different view on the two proposals—one in relation to continuous disclosure and one in relation to misleading and deceptive conduct.

In relation to continuous disclosure, I don't give a final view, but you'll see in my statement that I present at least three arguments in favour of the changes and at least three arguments against the changes. In relation to misleading and deceptive conduct, I have taken more of a view against the proposed changes. In the opening statement I put one argument in favour, and three or four arguments, in fact, against those statements.

That's a summary. I could go through all of it, but that would probably take longer than an opening statement. I can do that, if you'd like me to do that; otherwise I can answer questions. I'm in the hands of the senators at this stage.

CHAIR: If you're happy, Dr Duffy, I think we can go to questions, because we do have a short time frame. I'm sure that we'll get some of that evidence before us, anyway. I will hand over to Senator Walsh.

Senator WALSH: Thank you very much, Chair, and thank you so much, Dr Duffy, for being here today and for sharing with us your expertise and interest in this issue. I'll just start with a few very general questions about the consultation process. Dr Duffy, were you consulted by the Treasurer, his office or the Department of Treasury during the development of schedule 2 of the bill?

Dr Duffy : Going back to the PJC, I received a written invitation to submit to the PJC, and did so. I wasn't called before the PJC, and I haven't received any other communication since then, other than, obviously, being requested to submit to this committee.

Senator WALSH: You've obviously gone to the trouble of providing the committee with a detailed submission, and your opening statement last night as well. In your view, are the changes in schedule 2 significant changes?

Dr Duffy : To use a lawyer's phrase, they're not insignificant. Certainly, the proposals in relation to knowledge, intent and recklessness are significant. Negligence is perhaps not as huge a change, but it's still a change. They are not insignificant changes.

Senator WALSH: The Treasury have told us, as part of this inquiry, that they haven't consulted anyone about the proposed measures in schedule 2. They said that they did conduct some targeted consultations on the effects of the temporary changes to continuous disclosure laws in September last year. Those targeted consultations were with the Business Council, the Institute of Company Directors, the ASX and ASIC. Do you think that that level of consultation on these sorts of not insignificant, as you put it, changes is adequate?

Dr Duffy : My expertise is not in the consultative process; it's more in the law. They've consulted a number of stakeholders there. In the consultative process, perhaps the more the better, within reason. As I say, I'm not an expert in relation to what is an appropriate consultative process in relation to legislation. That's perhaps more one for the political process. Again, as a general principle, wider consultation is preferable.

Senator WALSH: You say in your submission, at paragraph 31, that the drafting of the proposed changes to the misleading and deceptive conduct provisions is not without considerable ambiguity. Could you elaborate a bit on the drafting issues that you've identified?

Dr Duffy : Yes, certainly. I'm not the only one that's made that point. Essentially, there are two issues in relation to these changes. One is the knowledge and awareness of the corporation. The other issue is in relation to what's called materiality or price sensitivity of information. That has generally always been considered to be a separate issue and an objective fact; that is, what a reasonable investor thinks about information and how it will affect the share price. That's a separate issue, and that has always been separate. The reasonable investor test is the definition in the current laws. The same test is used in the insider trading laws. It's the test under the ASX rules. A similar test operates in other countries as well.

My concern about the drafting is that it seems to conflate or bring together two issues. One is the issue of liability of the company and the knowledge of the company, and it mixes that up with the question of the objective materiality of the information, the price sensitivity of the information. I think it does that in a somewhat confusing way because it's no longer the test as to whether something is objectively material to investors. The test is mixed up with what the company knew or didn't know. I think it's confusing and it might even lead to somewhat perverse results.

One view—it's probably a bit of a cute legal view—of the drafting suggests that the question is whether they were reckless or negligent or knew about the question as to materiality rather than whether it was, in fact, material. You could get a finding in theory—I don't think this would happen in practice—that they were reckless on that matter, even though it wasn't actually material to the share price, anyway. I think it's somewhat confusingly drafted. It's different to the prior drafting, when these things were required under the old legislation, which was removed in the early 2000s. It's different to that. I think it's a bit ambiguous and confusing, having regard to the way it's drafted. I made that point in an article in the Company and Securities Law Journal, which is probably one of the leading corporate law journals.

Senator WALSH: There's some discussion in the submissions around the question of whether it's usual to include these sort of fault elements in civil penalty provisions. Could you give us your view on that? In your submission you make the point, in paragraph 29, and elsewhere in your submission as well, that the inclusion of fault elements in civil penalty provisions is unusual but not unheard of.

Dr Duffy : Yes.

Senator WALSH: There are other views that have been put. At the level of principle, could you confirm that it's not unusual for civil penalty provisions not to include a fault element?

Dr Duffy : On my review—I don't claim that it's absolutely flawless or exhaustive—I found two instances of them being included, but they're the only ones I located. The general principles of civil penalty provisions have been that, in some regards, at least in relation to criminal procedure, they have some elements.

In relation to the question of fault elements, my research suggests that it's unusual but not unheard of. The civil penalty provisions of the Corporations Law apply to a number of types of misconduct in the Corporations Law. My understanding is that, in relation to particular provisions, which are usually criminal provisions, they are not generally required. It's my understanding, and my review and research suggest, that it's a bit unusual, but not completely unheard of.

Senator WALSH: And just a final question from me, which is probably one that you might want to give a longer answer on but in the interests of time we'll try and keep it brief. My question is: what do you think the broader potential implications are of schedule 2 for the level of information in the stock market and what are the potential consequences for private enforcement of securities disclosures?

Dr Duffy : I think I make the point that it's a matter of getting the balance right and if you go too far in the other direction you may see a decline in private enforcement. You'll obviously have to get evidence from—and you obviously will get evidence from—the lawyers as to how difficult they think these cases will become to run under these provisions. But I suppose I make the point that if they become too difficult then they will obviously decline in numbers and you'll get less private enforcement of the security laws.

Exactly where the balance sits, I guess, is a policy question for senators at the end of the day but we're certainly moving towards making them more difficult. Certainly, as I say, knowledge and recklessness are going to be very difficult to prove. Negligence is going to be a bit harder but obviously not as hard as knowledge and recklessness. But as to where that will go, I can't predict.

Securities class actions—there are a few of them around at the moment. I suppose there will be fewer. You'll have to make a judgment, I guess, about the numbers that are around at the moment, whether it's an appropriate number or not. And that's perhaps a policy matter. But I think the general trend is that they'll be harder to run. I guess that is all I can really say about that. They'll be harder to prove. So that's probably about all I can say. But certainly knowledge and recklessness are going to be very difficult to prove.

Senator WALSH: I think we're moving to another senator. If there's time later I'll just ask one more question.

Dr Duffy : Thank you.

CHAIR: Senator Brockman.

Senator BROCKMAN: I understand you're an academic but what's your relationship, if any, to class action lawsuits? Do you appear as an expert witness? Do you advise any class action law firms that are undertaking class actions? I'll add that that seems to be the area where we have received the most concern.

Dr Duffy : A long time ago I worked briefly at a class action law firm and I have made that clear in my submission—I've disclosed that—for about four years. But that's quite a long time ago now. I have been approached as an expert witness once or twice but I declined. I have received funding—again, I disclose that in my submission—from a number of different firms, two of which I would describe as, I guess, plaintiff class action, and two I would not describe as plaintiff class action. But they're comparatively minor amounts of funding. And that was some time ago. I guess that's about the only real relationship that I can think of that I suppose is the situation at the moment.

But my view is that, as an academic, you're really required to try and give both sides of the argument. That's generally been my approach. And I've attempted to do that as much as possible today.

Senator BROCKMAN: Yes absolutely. And it's certainly not an accusation; it's just always good to get that on the record.

Dr Duffy : Yes.

Senator BROCKMAN: You talked about the fact there were other civil penalty provisions in the corps act that have fault elements. Did you look at the couple you identified as to why you think they would have had a fault element attached to them? Do you have any comment to make? I guess the main thrust of my question is: why should the civil penalty provisions we're talking about in this particular bill be strict liability?

Dr Duffy : I suppose we're moving from strict liability under the proposal to fault elements. As I say, in some of the submissions currently they are not what's called absolute liability; they are strict liability subject to a possible defence. And I do make the point that there is a defence or at least a right to put evidence to the court that the corporation acted honestly and fairly and can be excused. That's an existing right.

In terms of something I gave to the senators, I guess there were green, absolute-liability offences, there were red fault offences and in the middle there were blue ones which were a bit of mixture. At the moment this is a blue one but the proposal is to move it to a red one. I guess you need a reasonably good onus to show why this defence is not enough. The defence has been explored in, I think, some ASIC cases. I don't think it's been explored much in shareholder class actions. But I guess I make the point that I suppose there is some level of a defence there.

The onus of the defence is obviously on the defendants, and I suppose that's not something the defendants would prefer. They'd prefer to have the onus on the plaintiff to prove knowledge rather than their onus to perhaps prove honesty and lack of knowledge. So I guess that's the debate a bit.

But as to which way it goes, I guess I've put arguments both ways: there are some reasons to increase this to a fault liability but then there are some reasons against that, including this fact that there's already a defence there or a right to be excused for honest behaviour under the existing legislation. I don't say there's no arguments for these provisions but I say there are some arguments against them. I guess that's my position.

CHAIR: Senator Walsh, did you have another question you wanted to go to?

Senator WALSH: Yes, just one final question, Dr Duffy. You would be well aware that a couple of years ago the Australian Law Reform Commission did recommend a comprehensive review of continuous disclosure laws and they recommended that any such review undertake wide consultation, collect and draw from an evidence base and that the review should be conducted by agencies with sophisticated understandings of the regulatory provisions, class action law and procedure and the securities market. Do you think that the government should undertake that type of review? The recommendation wasn't acted on by government. Do you think that sort of review is in order?

Dr Duffy : I think that would be useful. It's obviously a complicated area. You get into some really complicated issues when you're talking about corporate knowledge. You're talking about companies that are a legal fiction and you're trying to work out what they're thinking and what they think or know or whatever. So it's a really complicated area, a really difficult area.

I suppose in terms of how we've got to where we are, there were temporary changes, I guess, for COVID and I suppose now the proposal is to make them permanent. Yes, I think perhaps a review of some sort, a detailed review, is certainly not going to hurt. I would have thought it would help. Yes, I would think that was an appropriate thing to do. I'm not sure how that fits in with the political process at the moment, given that these provisions are sitting there in the Senate and have gone through the House. I guess that's a matter for you to work out how that might occur.

Senator WALSH: You're right, we're already in a process with a much shorter time frame. Had we had that sort of review, would it have been helpful, would it be helpful at the very least with the sorts of drafting ambiguities that you identify in schedule 2 as it's presented today?

Dr Duffy : Yes, I think that would have been good. I think another person has made a point that I was going to make as well in relation to misleading, deceptive conduct changes, which I sort of have suggested shouldn't be made because misleading and deceptive conduct has never required fault elements as a general principle. It's different to continuous disclosure. It's never required fault elements. And the drafting of that is horrendously complicated too and, I think, probably somewhat problematic because it tries to carve out some type of non-disclosure but leaves other types of non-disclosure there presumably without fault elements and other types with fault elements.

In practice, you may get a company that basically says revenue has increased 10 per cent and makes an announcement. And that's all well and good. That sounds positive. And then they don't tell the market the costs have increased 20 per cent. They don't say that. The first statement is literally true. It's a positive representation. It's actually accurate but it creates a positive feeling when, in fact, the truth is that the overall situation, the overall impression that should be given, is a negative one.

You're mixing up these sorts of positive representations with lack of disclosure, and under these changes you're going to have misleading and deceptive conduct cases where defendants will have to argue that, in fact, to get the fault elements in they'll have to argue that they breached the criminal continuous disclosure requirements, which I presume they're not going to do. So I think there are a few issues and a few problems in relation to the actual drafting of both these changes.

CHAIR: Thanks, Dr Duffy, for appearing today. We really appreciate you giving us your time to appear before us.

Dr Duffy : Thank you, and I'm very grateful for the opportunity. And I thank the senators.