New Zealand: Due diligence process in Feltex IPO "very thorough"

Brief Counsel

The importance of robust due diligence processes in significant capital raisings is a key take-out from the High Court decision this week clearing the former Feltex directors from liability for shareholder losses.

The Court found that the company's 2004 IPO document was not misleading under the Securities Act.

Even had misleading statements been made, the Court considered the process by which the prospectus had been settled was so thorough that the directors could prove they had reasonable grounds to believe in the accuracy of its contents.

The context

The directors and others associated with the Feltex IPO were being sued by Eric Houghton on behalf of 3,689 former Feltex shareholders for losses they claimed arose from their reliance on misleading disclosure.

The prospectus, issued in May 2004, identified a number of risks to the company's future performance but generally portrayed an improving financial position. The end of year results for 2004 permitted a dividend above forecasts, but, by 1 April 2005, the company was issuing a profit downgrade. In September 2006, the bank appointed receivers, over the board's objection. In October its assets were sold to Godfrey Hirst and, in December, it was placed in liquidation, its shares worthless.

The Securities Commission conducted an inquiry into the adequacy of the disclosure and concluded in October 2007 that it was not misleading in any material respect.

The High Court decision

The Court found there was "some justification" for a number of the criticisms brought by the shareholders, but that they had not demonstrated that there were any materially misleading statements or omissions in the prospectus that would trigger liability under the Securities Act 1978 (SA).

In response to the submission that the prospectus overall conveyed an impression that the investment was less risky than it turned out to be, Dobson J found that argument "appeared stronger when invoked with the benefit of hindsight, than it did as a reconstruction of the position as reasonably apprehended by the defendants at the time".

The Court also found that, because the relevant behaviour was regulated by the SA, overlapping liability under the Fair Trading Act (FTA) would not arise. This finding confirms the effect of amendments made in 2006. The Financial Markets Conduct Act 2013 ( FMCA) likewise overrules the application of the FTA in relation to financial products and services and goes further, by requiring that the Commerce Commission get the FMA's permission before proceeding with an FTA misleading conduct claim in the financial services sector.

Similarly, the Court found that there is no place for any cause of action for negligent misstatement in these circumstances.

The Court had no difficulty finding that the Joint Lead Manager role fell within the ambit of the professional adviser exclusion to promoter liability, as has been widely assumed in practice. The FMCA takes a different approach by focusing secondary liability on those knowingly involved in a contravention, regardless of the nature of their role.

Much of the interest in the judgment sits outside the substantive findings of fact. Because it was said during the proceedings that appeals would be "inevitable", Dobson J thought it appropriate to record his views on other issues which could arise on appeal.

Two matters of particular relevance to directors and others responsible for document preparation to support a capital raising are:

  • the level of reliance required to trigger liability for civil compensation, and
  • the due diligence defence.

Level of reliance

One of the major reforms introduced by the FMCA is a presumption of loss provided for in section 496 (reflecting "fraud on the market" theory). This provides that if an investor sustains a loss, and there has been a disclosure contravention in an offer document, the loss will be attributed to the defect in disclosure unless it can be demonstrated that it was due to something else.

This is much more investor-friendly than the equivalent provision in the SA, and essentially turns the test on its head. But there is a two year transition to the FMCA, and the SA will continue to apply to those cases which predate its application, of which there are several in the pipeline.

Section 56 of the SA provides that civil liability for losses will be established if the person bought the securities "on the faith of" an untrue statement in an advertisement or registered prospectus. At issue was what this meant.

The shareholders argued that it "contemplated no more than investing in the knowledge that a prospectus existed."

The defendants cited the Court of Appeal1, stating that an investor must:

" reliance on a particular item or items in the [financial statements] which were inaccurate... For, if the inaccurate material was not an influence...., how can it be alleged that the investor would not have gone ahead with the investment".

They also drew on the explanatory note to the Financial Markets Conduct Bill explaining that, under the SA, it was difficult for investors to obtain compensation due to "the need for each investor to prove actual reliance on the misstatement that caused the loss".

But Dobson J went down the middle, saying that the legislative intention in the SA was to create a materiality threshold and that:

"There has to be a nexus between the loss sustained and the untrue statement, but not to the extent that requires the claimant to prove reliance directly on the untrue statement".

Due diligence defence

Under the due diligence defence, which has been carried through to the FMCA (along with two new defences), where there has been a defect in disclosure, directors can avoid civil liability if they can establish that they had reasonable grounds to believe that the documents were accurate at the time they were issued to the public.

Application of this defence would require a case-by-case consideration of the reasonableness of the belief claimed by each director in relation to any particular content that was found to be misleading.

Dobson J said that he did not need to go through this exercise as he had already found that the materiality test was not triggered. However, he made the general observation that the rigour of the due diligence applied in the IPO, which he described as "very thorough" and "conforming to best practice", would put the Feltex directors into a position of relative safety:

"[A]ll relevant components of the process by which the prospectus was settled were undertaken sufficiently thoroughly, and with the application of genuine consideration by those involved, so as to justify findings that the defendants could indeed prove that they had reasonable grounds for belief in the accuracy of what was produced".

Features of the due diligence approach which the Court commented on included:

  • responsibility for the preparation of the various components in the prospectus being allocated to the people best qualified to make those contributions
  • each of the three law firms involved being required to complete legal due diligence
  • Ernst & Young as the company's auditors being contracted to provide not only the usual statutory report but also a review of the manner in which the prospective financial information had been prepared (according to the Court, this second step was "novel" in 2004)
  • members of Feltex senior management specifically considering and signing off on the accuracy of how those aspects of the business in which they had particular expertise were described
  • the conducting of 11 further interviews with senior Feltex managers to test the reasonableness of statements for inclusion in the prospectus, and
  • Forsyth Barr and First New Zealand Capital, as Joint Lead Managers of the IPO, having representatives attend the due diligence committee meetings and being invited to comment as the content evolved.

For an in-depth analysis of how and where the FMCA departs from the SA, refer to the paper Ross Pennington prepared for the Banking & Financial Services law Association conference in August.

The information in this article is for informative purposes only and should not be relied on as legal advice. Please contact Chapman Tripp for advice tailored to your situation.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Roger Wallis
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions