Australia’s second securities class action judgment, a step back for plaintiff shareholders?

Key takeaways

The Federal Court’s decision in Worley¹ is only the second securities class action to reach judgment in Australia.

The decision highlights the importance of good corporate governance for potential corporate respondents of securities class actions. In particular, Worley indicates that courts may be unwilling to find against corporate respondents where public revenue forecasts are made with a reasonable basis, supported by well-documented decision-making processes at a Board and executive level. This remains the case even where it is later established that processes were deficient leading to inaccurate forecasts.

The decision also makes clear that courts will consider the whole body of relevant documentary and oral evidence, and may be reluctant to draw adverse inferences from a corporate respondent’s failure to call certain witnesses. Where it is uncontroversial that adequate discovery has been provided, it is no answer that there may be a degree of information asymmetry between an applicant shareholder and respondent corporate. In this respect, the decision highlights the evidentiary challenges faced by shareholder applicants.

Given the evidentiary difficulties exemplified in Worley, the decision may temper litigation funders’ willingness to fund securities class actions in Australia. That said, the decision largely turns on its own facts and its impact in this respect is unlikely to be significant.

The decision is now the subject of an appeal to the Full Court by the lead applicant. Irrespective of the outcome on appeal, the Full Court’s decision is likely to provide further welcome clarification for stakeholders operating in, and affected by, this developing area of the law.

As the Australian securities class actions market matures and more proceedings run to judgment, funders will have greater access to judicial guidance enabling them to more accurately price their risk. This may result in funders being more selective in the proceedings they are willing to underwrite. Alternatively, we may see greater variation in the funding terms and premiums offered as the risks of individual proceedings are more readily quantifiable by reference to the expanding body of case law.

Facts

Worley Limited (WOR) is an ASX listed entity which provides professional services to customers in the resources, energy and infrastructure sectors.

On August 14, 2013, WOR published an earnings guidance statement in the following terms:

While recognising the uncertainties in world markets, we expect our geographic and sector diversification to provide a solid foundation to deliver increased earnings in FY2014.

The reference to increased earnings was a reference to an expected increase in FY2014 NPAT from the FY2013 NPAT figure of $322m.

On October 9, 2013, WOR made a further relevant announcement to the market to the effect that its first-half result would be lower than in the prior year, but affirmed the August 2013 earnings guidance statement. That guidance was repeated on November 10 and 15, 2013.

On November 20, 2013, WOR then published a revised earning guide statement in the following terms:

On current indications the company now expects to report underlying NPAT for FY2014 in the range of $260 million to $300 million with first half underlying NPAT in the range of $90 million to $100 million.

Upon that announcement, the price of ordinary shares in WOR fell approximately 26 per cent.

The lead applicant, Mr Crowley, had purchased WOR shares on October 4, 2013 ahead of the November 2013 announcement.

Mr Crowley commenced a representative proceeding on behalf of persons who had purchased WOR shares in the period between August 14, 2013 and November 30, 2013 alleging various breaches WOR’s continuous disclosure obligations together with allegations of misleading and deceptive conduct.

Mr Crowley’s case

Mr Crowley’s case alleged contraventions of:

• WOR’s “continuous disclosure obligations” which arose under s 674 of the Corporations Act 2001 (Cth) (Corporations Act) and r 3.1 of the ASX Listing Rules.
• Proscriptions on misleading or deceptive conduct in s 1041H of the Corporations Act, s 12DA of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) and or s 18 of the Australian Consumer Law (being Schedule 2 of the Competition and Consumer Act 2010 (Cth) (ACL).

Mr Crowley ran 3 distinct arguments in the alternative, being:

• The budget case: alleging that WOR did not have a reasonable basis for making the August 2013 earnings guidance statement.
• The performance case: alleging WOR’s actual performance in the early months of FY2014 dissolved whatever hopes that had underpinned the FY2014 budget and, in particular, by late September 2013 WOR’s senior management was aware that the assumptions in the FY2014 budget were failing but did not revisit those assumptions.
• The consensus case: alleging that WOR was aware of a consensus expectation of market analysts that it would deliver between approximately $354m and $368m in NPAT for FY2014 and ought to have known from August 14, 2013 that its earnings were likely to fall materially short of that consensus expectation.

Fact finding process

Mr Crowley’s case relied heavily upon inferences which he submitted ought to be drawn from WOR’s failure to call certain witnesses.

In particular, Mr Crowley submitted that the failure of WOR to call Mr Holt, who was the Chief Financial Officer during the relevant period, gave rise to the inference that interview records which he had prepared for the purposes of a memorandum to the Board’s Risk and Audit Committee could be relied upon as an accurate description of the forecasting process actually followed by WOR.²

In support of this submission, Mr Crowley emphasised that he was disadvantaged vis-a-vis WOR as he only had access to discovered documents whereas WOR was in possession all available information concerning its FY2014 budget and its performance against that budget.³ Mr Crowley did not however make any complaint about that adequacy of WOR’s discovery.⁴

While accepting that adverse inferences of the type contended for by Mr Crowley could be drawn in certain circumstances, the Court held that it was necessary to look at “all the available evidence concerning the process to determine whether WOR’s failure to call one or more witnesses supports an adverse inference based on documentary evidence…or the oral evidence of [the key witnesses] each of whom was cross-examined by counsel for Mr Crowley”.⁵

The Court ultimately found that WOR’s witnesses were truthful and candid and that the full body of the documentary evidence supported the reasonableness of its impugned revenue forecasts. Accordingly, the Court was unwilling to the drawing of the adverse inferences proposed by Mr Crowley.

Findings as to alleged breaches of continuous disclosure obligations

The premise underlying Mr Crowley’s case in relation to the alleged breaches WOR’s continuous disclosure obligations was that WOR was required by s 674(2) of the Corporations Act to notify the ASX on each of August 14, 2013, September 21, 2019, October 9, 2013 or October 15, 2013 that:

• WOR did not have a reasonable basis for making the August 2013 earnings guidance statement (Material Information).
• WOR’s FY2014 earnings were likely to fall materially short of the consensus expectation of professional analysts covering the ASX and WOR securities that WOR would deliver between approximately $354m and $368m in NPAT for FY2014 (Earnings Expectation Material Information).

Before directly considering Mr Crowley’s continuous disclosure case, the Court undertook an extensive review of the evidence of the internal consideration and deliberation by WOR at a Board level of forecasted revenue during the relevant period. The Court ultimately found that there was insufficient evidence available to establish that WOR’s FY2014 revenue forecast lacked reasonable grounds when it was approved by the Board on August 14, 2013. It was also found that WOR had a reasonable basis for maintaining the August 2013 earnings guidance statement thereafter until the revised guidance was issued in November 2013.⁶

Against that background, the Court held that Mr Crowley’s case arising out of the non-disclosure of the Material Information failed because at “all relevant times, it was not the case that WOR did not have a reasonable basis for making the August 2013 earnings guidance statement”.⁷ Accordingly, the Court held that the so-called Material Information was not “information” to which s 674(2) of the Corporations Act applied.⁸

The Court similarly held that Mr Crowley’s case arising out of the non-disclosure of the Earnings Expectation Material Information also failed because, at all relevant times, it was not the case that there was a consensus expectation of professional analysts covering the ASX and WOR securities that WOR would deliver between approximately $354m and $368m in NPAT for FY2014. In those circumstances, the Court held the so-called Earnings Expectation Material Information was not “information” to which s 674(2) could have applied.⁹

In light of the above Mr Crowley’s case in relation to the alleged continuous disclosure breaches failed entirely.¹⁰

Findings as to alleged misleading and deceptive conduct

Mr Cowley’s misleading and deceptive conduct case alleged that by making, repeating and maintaining the August 2013 earnings guidance statement, WOR had represented without reasonable basis that:¹¹

• It expected to achieve NPAT in excess of $322m in FY201.
• It had reasonable grounds to expect that it would achieve NPAT in excess of $322m in FY2014.

The Court accepted Mr Crowley’s submission (based in part upon Beach J’s findings in Myer¹²) that the earnings guidance statement was a representation with respect to a future matter within the meaning of s 4 of the ACL and s 12BB of the ASIC Act. The result of that characterisation was that the representations would be deemed misleading if WOR could not establish that it had reasonable grounds to support the matters the subject of the representations when they were made.¹³

Accordingly, the onus was cast upon WOR to prove that it had a reasonable basis for making and maintaining the August 2013 earnings guidance statement. In this respect, the Court observed that the relevant inquiry was whether WOR’s senior executives and the Board were aligned in their expectation that WOR would achieve increased earnings in FY2014.¹⁴

By reference to the findings outlined above, the Court rejected that the budget process undertaken by WOR was not reasonable and also rejected that the Board did not have a reasonable basis for relying on the results of that process.¹⁵ Although the Court found there was some evidence to suggest senior management applied unreasonable pressure on offices in regional locations to grow revenue, the evidence was not found to show that particular integers or portions of the FY2014 budget were overstated or understated so as to be unreasonable or unjustifiable.¹⁶

The Court also held that it was not open on the evidence to find that the Board was insufficiently sceptical or inquisitive as (among other reasons) the available Board minutes did not support that inference.¹⁷

It followed that Mr Crowley’s misleading and deceptive was dismissed in its entirety.¹⁸

Disposition

In light of the above, the proceeding was dismissed with costs.

Will Worley result in a decreased willingness of litigation funders to fund securities class actions in Australia?

In finding that the alleged continuous disclosure breaches and misleading and deceptive conduct were not made out, it was central to the Court’s reasoning that there was insufficient documentary evidence to establish that the relevant earnings guidance statements were not well founded.

Interestingly, the Court found that WOR’s historic underperformance against its budgeted revenue forecasts was insufficient in isolation to warrant the conclusion that the Board had not exercised the requisite degree of scepticism in relation to the FY2014 budget.

In contradistinction to the decision in Myer, the decision in Worley was largely fact dependent. That said, Worley does indicate that securities class actions are unlikely to succeed where the respondent entity is able to adduce contemporaneous evidence of a reasonable basis for publicly made revenue forecasts, even where those forecasts turnout to be inaccurate.

The decision may prompt plaintiff law firms and litigation funders to undertake more extensive due diligence rather than commencing securities class actions off the back of a sharp share price decrease alone. It does however bear mention that the capacity of plaintiff firms and funders to undertake the requisite due diligence exercise may be hampered given corporate respondents’ internal documents are generally not given over until a discovery stage in proceedings.

In light of the above, Worley may have a moderate impact on funders’ willingness to fund securities class actions Australia. This impact is likely to be particularly apparent in factually similar cases involving inaccurate revenue forecasts resulting in sharp share price decreases.