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Economics References Committee
Treasury Laws Amendment (2021 Measures No.1) Bill 2021, Provisions

WATSON, Mr Andrew, National Head of Class Actions, Maurice Blackburn

ACTING CHAIR ( Senator Walsh ): I now welcome the representative from Maurice Blackburn Lawyers. Thank you for appearing before the committee today. Information on procedural rules governing public hearings has been provided to witnesses and is available from the secretariat. Witnesses should speak clearly and into their microphone to assist Hansard to record proceedings. I would also like to advise witnesses that answers to any questions on notice should be sent to the secretariat by 5.30 pm on Wednesday, 16 June 2021. Mr Watson, I invite you to make a brief opening statement, should you wish to do so.

Mr Watson : Thank you, Chair, and thank you members of the committee for the opportunity to give evidence on behalf of Maurice Blackburn regarding this important piece of legislation. Australia's continuous disclosure regime and its prohibitions on misleading and deceptive conduct are longstanding safeguards of market integrity. They ensure that the market trades on accurate information and in so doing promote the efficient allocation of capital and are a key plank in the regime of investor protection.

A little context demonstrates the vital nature of getting our market integrity and disclose regime right. The overall market capitalisation of the ASX is $2.4 trillion. Australia has one of the highest rates of direct share ownership globally, with approximately 35 per cent of adult Australians holding exchange investments. An even greater number have an indirect interest in shares through their superannuation, with approximately 16 million Australians, or more than 80 per cent of the adult population, having investments in super, according to the ATO.

When the Treasurer announced the bill under consideration by the committee he did so ostensibly to provide companies with greater certainty in making forward-looking statements. Under the existing legislation, a forward-looking statement does not have to be always right; it simply has to have reasonable grounds. So, for companies doing the right thing, the proposed changes are entirely unnecessary. There's no demonstrated need to change the law from that perspective.

The real vice in the proposed amendments is that they go far beyond providing merely relief for forward-looking statements. They actually provide a free pass for serious accounting misstatements and other forms of misconduct. Suppose a company publishes accounts which wrongly recognise revenue and therefore overstate profit by tens of millions of dollars. Under the current section 674, there would be a contravention of that provision and shareholders would be able to recover their losses.

Under the proposed new section 674A, the new misleading and deceptive conduct provisions, the company will be able to say that it relied on its auditors and was not therefore negligent. The auditors will then be able to say that they cannot be involved within the meaning of the section in a contravention by the company and avoid liability under section 674A. Because of the way the new misleading and deceptive conduct carve-out works, they won't be liable under that provision either. In effect, then, shareholders will go without compensation for something as fundamental as a misstatement of profit. As we point out in our submission, this may even be the situation where the company has actively misled the auditor or at least given it misleading information.

There's simply no good policy basis on which shareholders should be denied a remedy to recover their losses in circumstances of serious misstatement in financial accounts, yet that is the almost inevitable consequence of the proposed changes. As we note in our submission, one likely outcome, should the bill become law, is a veritable cottage industry of corporate lawyers signing off on disclosure, safe in the knowledge that the combination of legal professional privilege and the new provisions will ensure an effective free pass from any scrutiny as to whether or not the advice was based on misinformation or incomplete information from the company and/or whether the advice itself is negligent or wrong.

Another substantial problem is that the proposed legislation encourages the 'I know nothing' defence. The proposed new section 674A requires the entity to be negligent. This is described as introducing a mental element to the continuous disclosure regime. The company is vicariously liable for the negligent acts of its employees or agents, but the attribution of a state of mind is usually limited to its board and senior executives. Under the proposed new section 674A, boards and senior executives may be able to say that they were not negligent with respect to whether information should have been disclosed if they did not have that information. Companies will then, in effect, be rewarded for having deficient systems which keep boards in the dark.

The proposed legislation will weaken the continuous disclosure regime and the prohibitions on misleading and deceptive conduct, undermine investor protections and the efficient allocation of capital and diminish market integrity. It can only be seen as part of a suite of measures where this government has sought, in effect, to give corporate Australia a free pass on misconduct.

The wind-back of responsible lending laws, the failure to implement the Hayne royal commission recommendations, the various attempts to make class actions more difficult and the recent attack on proxy advisers, together with this attempted wind-back of safeguards of market integrity, are all part of a piece. They remove protections for investors and consumers and reward corporate wrongdoers. The proposed legislation should be rejected.

ACTING CHAIR: Thank you very much, Mr Watson. I'll kick off with a few questions and then we'll go to Senator Brockman. You said in your opening comments that for the vast majority of companies that are doing the right thing there's no basis for these changes and that they provide a free pass for those companies that might do the wrong thing. Are you able to explain how you think the changes to continuous disclosure that the government's trying to make could affect future corporate behaviour?

Mr Watson : Yes. I gave the example in my opening of the situation of accounting misstatements. That really is a very real and substantial problem. It's one of the circumstances which have led to some of the largest awards in favour of shareholders under the existing regime. Those sorts of accounting misstatements saw, in the Aristocrat case, $144 million awarded to shareholders and, in the Centro case, $200 million awarded to shareholders. Those cases are very important. Because of the way in which the legislation worksit says that the entity will be not liable under section 674A unless it intends to mislead or is reckless or negligentit leads to a situation where the entity will, when it releases accounts that are wrong, be able to say, 'Well, we relied on our auditor'.

Under the existing legislation, we would sue the company and we'd sue the auditor and, in effect, let them sort out where the wrongdoing lay. But, under this legislation, the company will be able to say, 'We relied on our auditor, therefore, we weren't negligent'. What that will mean, thoughand this is the consequenceis that the legislation provides for liability of others where they're involved in a contravention, but the auditor will be able to say, 'We weren't involved in a contravention because there was none'. So the auditor will miss liability under section 674A; and so will the company.

None of that would matter quite so much except that now the proposed legislation also seeks to amend the misleading and deceptive conduct provisions so that things which would once have been a contravention of 674, but not a contravention of 674A, are exempt from the misleading and deceptive conduct provisions. What the legislation does then, in relation to that accounting misstatement that I've talked about, is give the company a free pass on misleading and deceptive conduct, even though the accounts might have overstated profit by hundreds of millions of dollars or tens of millions of dollars, and it will give the auditors a free pass because, again, they will not be liable under 674A either.

What you've ended up withone presumes it's an unintended consequence, but if it's not intended, it is disgracefulis that, in an attempt to fix up a problem that didn't exist in relation to forward-looking statements, a much larger problem has been created, which is a free pass for this kind of misconduct.

ACTING CHAIR: In your submission you really go into some detail about the problem of how potential shareholder actions could be bounced between company directors and their auditors. You cite an example of a company publishing accounts which overstate profit by tens of millions of dollars and shareholders acting on the basis of that information and subsequently suffering a loss. Can you elaborate on that example and, in particular, explain how, under the current law, shareholders would be able to hold that company accountable, and then explain how the same shareholders might fare if schedule 2 were passed?

Mr Watson : Under the current legislation, if the profit was misstated, that would be information which a reasonable person would expect to have a material effect on the price or value of the shares, so it would fall within the existing provisions of section 674. In addition, to the extent that the company had represented that its profit was 200 million, when in fact it was 100 million, it would have made a misleading and deceptive statement to the market and would have liability under section 1041H of the Corporations Act and the provisions of section 12DA of the ASIC Act.

Under those provisions, there'd be a contravention and then, under various provisions of the act, shareholders would be able to recover any loss they had suffered from that contravention. As I indicated in my answer to the previous question, in some cases those recoveries have been very substantial by way of settlements that run into the hundreds of millions dollars: Centro, 200 million; Aristocrat, 144 million; and I think in the QBE we got 135 million. Those are situations where there were substantial recoveries for significant misstatements in accounts.

As I indicated, the issue is that, by changing the standard in the way that is proposed, the company will be able to say, 'We relied on our auditor. We weren't negligent; we relied on our auditor'. So no liability will be visited under section 674 in relation to the company but, because of the way in which the change to the misleading and deceptive conduct provisions is being done, because there would have previously been liability under section 674 and there is not now liability under section 674A, that conduct will now be exempted from misleading and deceptive conduct provisions. In other words, we end up with a situation where something which is egregiously wrong ends up not being able to be recovered under 674A or under the misleading and deceptive conduct provisions. That flows through, as I've indicated, to the position of the auditor.

The auditor is not liable under 674A because they can't be involved in a contravention which doesn't exist and, because of the same operation of the provisions in relation to misleading and deceptive conduct, they are not liable for misleading and deceptive conduct either.

It's an outcome that, as I say, I don't anticipate was intended. If it was, as I say, it's disgraceful. But it's an indicator of why these things should not be done on the run. This legislation was whipped up allegedly in response to COVID, in circumstances where it was entirely unnecessary in its first iteration; then it was attempted to be rushed through when the COVID exemptions were about to expire, but it bears all of the hallmarks of policymaking on the run, without proper consideration.

ACTING CHAIR: Going to that question of consultation, there's been no specific consultation engaged in by the government on schedule 2, but, as you're aware, there have been some broader reviews. Would you describe the changes in schedule 2 as significant? Given that Treasury has told us that they didn't consult a single person about the proposed measures in schedule 2, are you concerned about that level of consultation?

Mr Watson : Undeniably. The starting point for all of this, as I say, is that, when the Treasurer made his statement, he indicated that he was concerned about forward-looking statements not being the subject of what he described as 'opportunistic class actions'. Let's understand some context about that. Firstly, the total number of shareholder class actions in 2019 was 10, and not all of those were about forward-looking statements. So we're talking about, in that circumstance, less than 10 class actions that were aligned with forward-looking statements.

In relation to forward-looking statements, this legislation really does nothing, because the existing law makes it clear that a forward-looking statement is only actionable if it's without reasonable grounds. Indeed, some the authorities suggest that under section 674 it doesn't even matter whether it has reasonable grounds; it only has to be honestly made. Certainly, under the misleading and deceptive conduct provisions, it must have reasonable grounds.

There was already a test there which said that the statement didn't have to be right; it just had to have reasonable groundsin other words, not negligently made. To that extent, forward-looking statements are completely unaffected, one way or another, by this legislation. So the legislation fixes a problem that didn't exist and doesn't advance things at all. What it does is to create a potential series of other real problems that, as I say, I imagine were unintended, and does so because, frankly, insufficient care or thought were given to all of those ramifications and people weren't asked what the implications might be.

ACTING CHAIR: Can you explain, in general layperson's terms, how difficult it is today for shareholders to mount a case? You've cited numbers, and we've had them cited earlier today as well, that there's a relatively low and declining number of shareholder class actions, at any rate. Your submission goes to this question of how these changes impact the initial discovery process and how shareholders can even get information to get a foot in the door and see whether they've got a case to advance. Can you explain how difficult it is today, and what barriers these changes put up to shareholders, particularly in relation to the impact on discovery?

Mr Watson : Yes. The reality is that we have never had very many shareholder class actions in this country, despite the hysteria that is sometimes associated with these debates. I think the maximum number we ever had was 27 in a calendar year, and that was influenced by the fact that there were multiple filings in respect of a number of companies, the most notable of which was that there were five cases in relation to AMP revealing that they had charged a fee for no service. So the 27 itself is a bit of a misnomer, because in fact the number of companies that were being sued was much smaller.

There have never been terribly many. The reason that there are never terribly many cases is the reality of our system, which is that there is an adverse cost penalty if you lose. If you run a case and you're unsuccessful, you pay the other side's costs. No-one in their right mind, least of all me, is going to institute a case where you start off at serious risk that you're going to lose, and you're going to pay the other side's costs.

There's always been that structural difference between our shareholder class actions and those in the US, for example, or even in Canada, where the prevalence of shareholder class actions is much greater than we have.

Cases are hard to start, partly because, as shareholders, we are standing on the outside looking in. We do not have access to internal materials. We have to rely on the public announcements of the company. There's a perversity in the way the law works, where we can't, frankly, talk to whistleblowers, even if they volunteer to come and talk to us. We've had a number of situations where we've sought to talk to whistleblowers and not been allowed to; most recently in Crown. We went to the court and asked whether we could talk to a whistleblower who wanted to talk to us. At first instance the court said, 'Yes, you can.' A full court overturned that judgement and said that we couldn't because of the confidentiality obligation that the whistleblower owed to the company.

We can't talk to whistleblowers. We're reliant on public information. That means, in effect, that working out who knew what in a company, when they knew it and how they knew is very difficult, and not something we find out, usually, until after discovery. You can allege, as we often do, that something would reasonably have been anticipated to affect the price of the share, which is the current test. But requiring a plea of intention, recklessness or negligence requires them to say who was negligent, who knew, who was reckless, and when they knewall things which, as a general rule, we don't find out until discovery.

The practical consequence of legislation like this is that there will be some cases where we're simply unable to pursue circumstances which, on the face of it, call out for a remedy simply because we won't have the information when we commence the proceeding.

ACTING CHAIR: I will ask Senator Brockman whether he has any questions.

Senator BROCKMAN: You've covered most of the areas I wanted to cover. I'll ask the question that I've asked other witnesses, which turns the question around. We have heard from previous witnesses that the fault element does appear in other civil penalties under the Corporations Act. You've already covered this, but is there anything else that you want to add as to why you think strict liability should apply to civil penalties in this particular area?

Mr Watson : I have, to some extent, covered it, but it's important to understand, too, that the fault element that is being introduced here is a particular kind of fault element. I noticed, in the parliamentary report and again in the Treasury justification for this legislation, this drawing of analogies with the US and UK systems, which require a fault element, saying, 'This will just bring us into line.' But that's where one has to examine properly what the fault element that's being introduced is and what its consequence is.

This is not a general negligence test that's introduced. In other words, was the company negligent, full stop, with respect to its behaviour? This is negligence specifically with respect to the question of whether or not information which the company hadnot ought to have hadwas going to be material to price or value. This is where it's critical to unpack what's actually going on with the legislation as opposed to recourse to generalities about fault elements generally.

This legislation introduces a particular test which has a particular consequence. The seriousness of that consequence is something which I do not think has been properly understood. The seriousness of the consequence is, as I say, in relation to situations such as the accounting misstatement and other things, where the way in which the fault element that's been introduced in this instance will work is one which is not the way in which the fault element in the US or the UK works. I can tell you, frankly, in the US and the UK, the fault element that they have would allow you to sue a company that has misstated its profit. That is why one needs to analyse it by reference to the specifics of what will occur rather than a general recourse to notions of whether or not fault elements are a good or a bad thing.

Senator BROCKMAN: I'm happy to leave it there, Chair. I think we're almost out of time, anyway.

ACTING CHAIR: Yes. Thank you very much, Mr Watson, for appearing as a witness today. We really appreciate your time and expertise.

Mr Watson : Thank you.