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Lombard Decision

30 Mar 2012

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Lombard Decision

Directors Sentenced

The Lombard directors were sentenced in the High Court in Wellington yesterday (29 March 2012). The four directors were sentenced to community service: 300 hours for Sir Douglas Graham and Lawrence Bryant; 400 hours for Bill Jeffries and Michael Reeves. Graham and Bryant were also ordered to pay $100,000 each in reparations. These sentences were lighter than those handed down in the previous Nathan and Bridgecorp cases. The differentiating factors include:

A shorter period of offending during which the misleading offer documents were in use to solicit funds (101 days in Lombard compared to 250 days in Nathans).
A materially lower level of culpability, towards the lower end of any scale in the Judge's view (eg no related party transactions, no personal gain, only misleading statements on liquidity); at most this placed them on the cusp of a custodial sentence.
The directors were scrupulous about seeking and acting on expert advice (cf Nathans).
There was no intention to mislead, they tried to deal honestly with investors but made a material misjudgement about the disclosure of liquidity.
It was recognised that the fact of a conviction in itself was a "blight" on their reputations, especially those of Graham and Jeffries whose reputations had been their most valuable assets.
For the executive director, Reeves, there were extenuating circumstances including his battle with cancer and his responsibility for dependent children.
Neither Reeves nor Jeffries were in a position to pay reparations and, in part, that led to the higher level of community service hours.

The previous good character of the non-executive directors proved to be a double-edged sword for them. Normally, this is a mitigating factor in sentencing. In this case, it was not so influential as it was the good reputation of the directors which drew investors to Lombard in the first instance.

The Lombard case will continue with the appeal of Bill Jeffries over his conviction and possible civil claims that have been foreshadowed by the receiver.

1 March 2012

Key Messages for Directors

Last week's Lombard decision added another dimension to the findings of the earlier cases involving director liability, both here and in Australia.

Many of the earlier cases focused on fundamental shortcomings in corporate board behaviour. Lombard was clearly at the other end of the spectrum. The competence and capability of the board was not in question. Nor were there any related party transactions or concerns regarding conflicting interests.

The case primarily concerned the quality of disclosure under updated offer documents Lombard issued in late December 2007. Lombard suspended payment on 2 April 2008, and went into receivership on 10 April 2008. A key focus of the case was whether the offer documents properly reflected Lombard's financial position at the time they were issued, and continued to do so during the period of their "distribution" up to early April 2008.

The reason for the guilty verdicts was quite simply a material misjudgement which occurred in the preparation of the offer documents. There was a failure to describe the state of Lombard's financial health adequately, for which the directors were ultimately held responsible.

The tests applied in the earlier Nathans case were largely adopted by the court. In particular, the court reiterated that directors' obligations in relation to the accuracy of offer documents are non-delegable. While directors' reliance on the judgment of management is generally appropriate, it is not acceptable to do so unquestioningly until directors are actually on notice that something has gone wrong.

Directors must exercise judgment at all times, and test the competence of management whenever there is any signal that this could be appropriate. In the Lombard case, this should have occurred when it appeared a pattern of inaccuracy was emerging in management's predictions around loan repayments. These repayments went to the heart of the company's financial stability.

There was also detailed consideration of specific disclosures in the Lombard offer documents, as part of the analysis to determine whether key information had been withheld. There are some key messages here for directors and others involved in preparing and vetting offer documents. In particular:

Look at the overall context of the commentary in the offer document and its discussion of risks, and make sure the business, and its key risks, are presented accurately in that context.
You cannot hold back from disclosing key judgment calls that you are making, if those calls are potentially critical to the organisation (eg reliance on management forecasts where you have evidence that they have previously been unreliable).
Be wary of emerging patterns of behaviour. If these could be material, they should be disclosed.
The disclosure regime for offer documents is there to put sunlight on issues for new investors to consider. You cannot approach the content of offer documents on the basis that you need to balance disclosure against the interests of existing stakeholders, and not jeopardise the ongoing business in what you might say.
Copying market practice for disclosure of particular risks is not a safe harbour.
If you sign the offer document, you are the final filter. Just because your managers and professional advisors have approved it does not mean that you are off the hook. You need to read and think about the document yourself.