THE FORTESCUE DECISION IN THE HIGH COURT

Introduction ASIC has had a difficult and ultimately unsuccessful pursuit of Fortescue Metals Group Limited (FMG) and its former Managing Director Andrew Forrest (Forrest). ASIC alleged that FMG had overstated the effect of framework agreements which FMG signed with three Chinese government owned contractors in 2004 to build and finance the infrastructure for FMG s then embryonic iron ore project in the Pilbara. In particular: FMG s announcements were misleading in referring to the 3-4 page framework agreements as binding agreements ; and FMG should have immediately corrected the announcements under its continuous disclosure obligation. The High Court 1 disposed of ASIC s claim on the basis that FMG s statements were not misleading. Hence there was nothing that FMG was required to correct. The significance of the decision Due to the way the High Court disposed of the case, a number of the potentially key issues on continuous disclosure which arose in the decisions of the lower courts 2 were not explored. The High Court s decision has however provided some guidance on misleading and deceptive conduct, including that: the audience of a statement made by a listed company to the ASX should be taken to be reasonably commercially sophisticated; and in assessing whether a statement would mislead that audience, the statement should generally be confined to what it actually says, rather than what implications or conclusions might (or might not) flow from it. Further, whilst the decision did not say anything directly about continuous disclosure: it is reasonable to conclude that the class of investors to be considered in assessing whether information is material would be the same reasonably commercially sophisticated audience identified by the High Court; and the High Court s approach to determining whether a statement of information is misleading tends to support the view that the information to be assessed for materiality is defined by reference to the company s perception of it, rather than by how someone else might characterise it. ASIC s case The High Court criticised the way ASIC had pleaded its case but essentially it was as follows: FMG s announcements that it had entered into binding agreements were (objectively) not correct, so its announcements were misleading or deceptive under s1041h of the Corporations Act. If FMG s announcements were statements of its opinion that the agreements were binding agreements, FMG either did not genuinely hold that opinion (effectively it was a dishonest or fraudulent statement) or it had no reasonable basis for that opinion. 1 Forrest v Australian Securities and Investments Commission [2012] HCA 39 2 Australian Securities and Investments Commission v Fortescue Metals Group Ltd (No 5) [2009] FCA 1586 (Gilmour J); Australian Securities and Investments Commission v Fortescue Metals Group Ltd [2011] FCAFC 19 (Full Federal Court) 1

Having made misleading announcements that the agreements were binding agreements, FMG was immediately obliged to correct the announcements under its continuous disclosure obligation in s674. Forrest, FMG s Managing Director at the relevant time, was personally liable for involvement in FMG s misleading and deceptive conduct and continuous disclosure breaches. Forrest breached his duty of care and diligence under s180 by failing to prevent FMG s misleading and deceptive conduct and continuous disclosure breaches. The High Court s response There was a joint judgment by French CJ, Gummow, Hayne and Kiefel JJ. A separate judgment was delivered by Heydon J. The joint judgment It was necessary to identify the target audience of the announcements and the messages conveyed to that audience. The intended audience: 3 can be sufficiently described as investors (both present and possible future investors) and, perhaps, as some wider section of the business or commercial community. It is not necessary to define the target audience more precisely. And the question was: 4 When that audience was told that [FMG] had made binding contracts with identified Chinese state - owned entities, what would they have understood? That audience would not have asked a lawyer s question about what would happen in court if the parties to the agreement fell out. Rather, they would take what was said as a statement of what the parties to the agreements understood and intended would happen in the future. 5 It was too broad a proposition that by using the terms contract or agreement the announcements conveyed a message about the legal quality of the contract or agreement. 6 FMG s announcements would have been understood by the intended audience to convey that FMG and the Chinese SOEs had entered into agreements that each intended to be binding. That was accurate and not misleading. There was no evidence to show that the intended audience would have understood that the parties had entered into agreements that would be enforced by an Australian court according to Australian law should a dispute arise and the fact that the agreements were with Chinese SOEs and were signed in Beijing pointed to the real and lively possibility that the formal and essential validity of the agreements might be governed by the law of the People s Republic of China, not Australia. 7 FMG s statements were objectively correct statements of fact as to what FMG and the Chinese SOEs 8 had said and done, so there was no issue of whether the statements were opinions genuinely or reasonably held 9 - and in any case ASIC had not established that FMG did not believe that the agreements were binding. 10 3 At [36] and see also [39] 4 At [36] 5 At [37] 6 At [38] 7 At [47] 8 State Owned Enterprises 9 At [65] 10 At [42] 2

Heydon J s judgment Heydon J in a separate judgment differed from the joint judgment on the question of whether FMG s statements were of fact or opinion. Heydon J considered that FMG s statements - that it had entered into binding agreements involved a question of law and hence necessarily required the expression of an opinion. 11 (That was the approach taken by Gilmour J at first instance, an approach which was roundly rejected by the Full Federal Court.) Heydon J considered that FMG genuinely and reasonably held that opinion. (We will return to this point below.) The conclusion Since FMG had not been misleading in announcing that it had entered into binding agreements, the issue of whether it should have disclosed under s674 that the agreements were not binding did not arise. Similarly, the issue of whether Forrest was involved in any contravention of s1041h or s674, or breached his duty under s180, did not arise. The merits of the decision ASIC would be entitled to be disappointed by the decision, among other reasons because FMG won the High Court appeal on points which FMG did not appear to have argued, including: that the target audience of FMG s announcements would not have taken FMG to have suggested that the framework agreements were not open to legal challenge in an Australian court; and that the target audience would not have assumed even that the agreements were enforceable in an Australian court. 12 FMG was defending a claim that it had misleadingly overstated the effect of the framework agreements. One can understand if it did not seek to argue these points. ASIC may also be disappointed by the joint judgment s finding that the words binding agreement did not (in effect) mean binding agreement as a matter of law. One could forgive someone (particularly a lawyer) for considering that those words are legal words which surely must be given their legal meaning. However, the existence of a binding agreement would not, of itself, be a material matter for the intended audience (of investors). What would be material to that audience would be the practical commercial consequence. The essence of ASIC s case (as identified by the High Court) was that FMG s announcements conveyed to the intended audience that, since FMG had entered into binding agreements, it was practicable for FMG to force the Chinese SOEs to build the infrastructure 13 presumably by court action to enforce the framework agreements. 14 The High Court in the joint judgment said it was extreme or fanciful that the intended audience of FMG s announcements would have drawn such a conclusion: 15 11 At [94] 12 In argument, David Jackson QC for FMG said There was a recognition that both Australian and Chinese law might apply to [the framework agreements], but there was no suggestion, in our submission, that the statements being made about them were other than statements relating to them being binding according to Australian law. As the matters have developed there is nothing to suggest that they were not binding in Chinese law, so that one is left in a situation that the relevant law would be Australian, in our submission. See [2012] HCATrans 48 (29 February 2012). 13 Joint judgment at [50], Heydon J at [104]. 14 Heydon J at [105] 15 At [50]. Emphasis in original text. 3

it would be extreme or fanciful for the audience to understand the impugned statements as directing their attention to any question of enforcement by an Australian court if the parties later disagreed. Such an extreme or fanciful understanding should not be attributed to the ordinary or reasonable member of the audience receiving the impugned statements. Heydon J in his separate judgment put this point rather colourfully: 16 an audience which read Fortescue's statements that way might be expected to ask: how is a State-owned enterprise of the People's Republic of China to be forced to do anything? When Bismarck was asked during the war of 1870 how he would force the British Army to surrender if it landed on the Baltic Coast, he said he would send a police constable to arrest it. Fortescue's target audience would have known that it would be very much less easy for Fortescue to deal with the People's Republic of China. It would have known that the idea that CREC would perform the agreement against its will was idle. It would also have known that even if the expression "force CREC to design... the railway" were used less strictly to mean "sue it for damages for breach of contract", then difficulties of execution would mean that Fortescue could not force CREC to conform with its will by those means. These considerations suggest strongly that Fortescue's target audience would not have understood the representations in the way ASIC wished. It would have understood them as being less high and less intense. So the audience of FMG s announcements would have (correctly) understood that FMG had entered into binding agreements with the Chinese SOEs to build the infrastructure, but it would not have understood that to mean that the infrastructure would necessarily be built, or that FMG would have a substantial right to compensation if it wasn t. It is difficult to criticise that logic from the assumed viewpoint of a commercial investor (as opposed to a lawyer). As was said in the joint judgment: 17 It is surely relevant to ask whether the public expression of acceptance by such a state-owned entity of what were described as "binding" obligations may not have been a much more powerful spur to performance of its obligations than any possible legal action instituted by Fortescue. Again, for that audience to form such an understanding would be far from "extreme or fanciful". But these issues were not explored, because the Full Court and ASIC incorrectly assumed, rather than demonstrated, that an inquiry into the "effect" of the agreements required an inquiry into their legal effect under Australian law. One can extrapolate that, commercially, the entry into the framework agreements would have been considered by investors as a positive for FMG s iron ore project. Three large Chinese SOEs had publicly committed to what they were apparently content for FMG to refer to as binding agreements. However, that positive could not be taken at the flood. It did not mean the infrastructure would necessarily be built. 18 The decision may lead to calls for changes to the continuous disclosure obligation, but that would be misguided. ASIC has suggested that there may need to be some clarification of the extent of detail required of listed companies when they announce the entry into contracts. 19 FMG was an unusual case, and quite fact-specific, and it should not be allowed to result in bad law. The High Court made plain that its judgment should not be taken to establish any general proposition to the effect that any public statement that Company A has made a contract with Company B necessarily conveys to its audience a message only about what the contractual document contains. 20 16 At [105] 17 At [49] 18 Indeed, as was made clear in Gilmour J s decision at first instance, at that time it was generally known that it FMG s project had not been determined to be feasible a definitive feasibility study had yet to be completed. 19 ASIC Media Release 12-244, 2 October 2012. 20 At [69] 4

Implications for misleading and deceptive conduct The target audience The High Court s approach suggests that the target audience of a statement made by a listed company to the ASX in relation to developments affecting the company s business can be assumed to be present and future investors and some wider section of the business or commercial community. Whilst the joint judgment did not say so in terms, it can be taken from its decision that that audience would be commercially sophisticated. That audience would have understood FMG s statements in their commercial effect, not in their legal effect. Heydon J was more specific (and again colourfully so). The target audience comprised: superannuation funds, other large institutions, other wealthy investors, stock brokers and other financial advisers, specialised financial journalists, as well as smaller investors reliant on advice. This was not a naive audience. It was not an audience in whom the adjectives "Western Australian", "mining" and "Chinese" would excite a sudden certainty about the imminent creation of wealth beyond the dreams of avarice. It was an audience conscious of the difficulties of creating infrastructure for mining projects in the harsh conditions of Western Australia. It was an audience conscious of their vast expense. It was an audience conscious of the problems of doing so in cooperation with a Chinese group described in the ASX announcement as China's largest construction group. And it would have learned not from the announcement itself but from the simultaneous media release that CREC was "a State-owned enterprise in China", the state in question being the People's Republic of China. The audience was sufficiently tough, shrewd and sceptical to know something of the difficulties of "forcing" a builder to build and finance anything. No doubt investors in a listed company will comprise both the sophisticated and the unsophisticated, but as noted in the High Court s decision in Capomar Sociedad, Limitada v Nike International Ltd 21, which was referred to in the joint judgment on a number of occasions, 22 one should consider the ordinary or reasonable member of the target audience. The High Court s approach to how the (commercially sophisticated) business or commercial community would understand a statement by a listed company to the ASX suggests that one should tend to confine such a statement within its four corners and not read in implications, conclusions or consequences which merely might but might well not flow from it: 23 The impugned statements conveyed to their intended audience what the parties to the framework agreements said they had done make agreements that they said were binding and no more. Possibly, the test may be what the (commercially sophisticated) business or commercial community would understand the company to mean by the statement it makes that is, what does the company intend to convey. This is not to suggest that the words should be taken to mean what the maker subjectively meant by them, 24 but rather what the audience would ordinarily determine the maker to mean by them, taken in their full context. It has often been suggested that when considering the adequacy of market disclosures, the way they would be understood by the mum and dad investor should be the touchstone. The High Court s decision suggests that the mum and dad investor should not be considered to be the ordinary or reasonable member of the target audience. 25 21 [2000] HCA 12 22 At [43], [49] and [50]. 23 At [50] 24 Like in Alice in Wonderland: When I use a word, Humpty Dumpty said, in rather a scornful tone, it means just what I choose it to mean - neither more nor less. 25 In this regard it may be that the High Court was influenced by FMG s status at the time the announcements were made. It was a highly speculative mining stock. It may be argued that the ordinary or reasonable member of the 5

A more realistic approach to honest misleading and deceptive conduct? The approach in the joint judgment of confining the alleged misleading statement to its precise terms (having regard to how it would be understood by a commercial audience) tends to suggest a view that the reach of misleading and deceptive conduct is not as broad as some lawyers and regulators have tended to assume. There are other indications of a less expansive approach to the assessment of a statement as being misleading and deceptive. Firstly, the joint judgment observed that the likely to mislead or deceive limb of s1041h adds little or nothing to the question of whether the prohibition has been breached. On this point it said: 26 the inquiry into how an ordinary or reasonable member of the intended audience would receive a message is of its nature hypothetical. That inquiry is therefore apt to answer both whether conduct is misleading or deceptive and whether it is likely to mislead or deceive. Separate consideration of this limb of s 1041H is therefore not necessary once it is decided that an ordinary or reasonable member of the audience would not have understood the impugned statements to have conveyed anything other than what the parties did and intended, and that the statement made about those matters was neither misleading nor deceptive. Secondly, Heydon J s made some interesting observations (albeit obiter and inconclusive) on the issue of whether a statement of opinion necessarily carries with it the implication that the opinion was formed on reasonable grounds. His Honour referred 27 to the Full Federal Court decision in Global Sportsman Pty Ltd v Mirror Newspapers Pty Ltd 28 which he said originated the fact/opinion distinction 29 in the field of misleading and deceptive conduct. His Honour observed that whilst that case made clear that an expression of opinion conveys that the opinion is in fact held, it was not authority for the proposition that there must necessarily be a basis for the opinion, let alone that the basis must be reasonable. His Honour said: 30 The matter calls for examination on some future occasion. Certainly, the creation of a widespread duty to have reasonable grounds if offering an opinion is but one example of the way the model for s 1041H, namely s 52 of the Trade Practices Act 1974 (Cth), has been widened since its inception. Liability has widened. Curial jurisdiction has widened. And the power of judges, in every sense of those words, has widened perhaps with Actonian effects. 31 Thirdly, the joint judgment responded to a potential suggestion (based on comments by Keane CJ in the Full Federal Court) that the conclusions reached in the case would artificially limit the protection afforded to the investing public. As well as making the point that the decision was quite fact specific, 32 the joint judgment said: 33 any concern about "artificially limiting" the protections conferred by prohibitions upon misleading or deceptive conduct would be driven largely, perhaps even entirely, by a concern with cases of fraud or dishonest attempts to characterise wrongly the effect of what has been said. target audience of a blue chip company such as one of the big 4 banks - would include the mum and dad investor. However the High Court s definition of the target audience seems generally applicable. 26 At [59] 27 At [94] 28 (1984) 2 FCR 82 29 At [103] 30 At [103] 31 A reference to John Emerich Edward Dalberg Acton, first Baron Acton (1834 1902), an historian and moralist to whom the adage: Power tends to corrupt, and absolute power corrupts absolutely is attributed. Apparently the sentence appeared in a letter by Acton to Bishop Mandell Creighton in 1887. 32 As noted above, it was said that the judgment should not be taken to establish any general proposition to the effect that any public statement that Company A has made a contract with Company B necessarily conveys to its audience a message only about what the contractual document contains 33 At [70]. 6

By raising and then responding to this suggestion in this way, the High Court appears to have appreciated that its decision had mandated a narrower approach to an assessment of the effect of an honest statement which is alleged to be misleading and deceptive. Implications for continuous disclosure The High Court s decision has no direct relevance to continuous disclosure. However there are aspects of the decision which may well have some indirect relevance. The target audience There is no definition of the target audience which applies for the purpose of the misleading and deceptive conduct prohibition in s1041h. The target audience is determined by reference to all the circumstances in which the statement is made. In this case, the target audience of a statement made by FMG to the ASX relating to developments in FMG s business was the (sophisticated) business or commercial community. In the continuous disclosure context, there is a criterion which applies (in s677) in determining when a reasonable person would expect information to have a material effect on the price or value of shares if the information were generally available. That criterion describes a class of persons (in effect, an audience) who may be influenced to acquire or dispose of shares specifically, persons who commonly invest in shares. It would be reasonable to conclude that the class of persons to be considered in the continuous disclosure context would be no wider than the class of persons who constitute the target audience (in the context of misleading and deceptive conduct) of a statement made by a listed company to the ASX relating to developments in its business that is, (sophisticated) business or commercial community. The s677 test does not refer to any person who commonly invests in securities but persons (generally) who so invest. It would be reasonable to conclude that one should consider the ordinary or reasonable member of that class in the same way as one considers the ordinary or reasonable member of the target audience in the context of misleading and deceptive conduct. If the target audience for the purpose of s677 is in effect the (sophisticated) business or commercial community, common sense suggests the ordinary or reasonable member of that community is not gullible or excitable, or skittish when confronted by risks inherent in any business or commercial undertaking. The ordinary or reasonable investor should not be considered to be the unsophisticated mum and dad investor. Whilst some unsophisticated mum and dad investors no doubt commonly invest in securities, it is unlikely that they would be considered to be representative of the ordinary or reasonable member of the business or commercial community. On this basis, in determining whether information is material, the question is whether the information would influence an essentially commercial, fairly sophisticated, mostly rational investor to buy or sell. Defining the information It is reasonably clear by such limited authority as there is on continuous disclosure 34 that the information to be assessed for materiality (generally, its potential effect on the share price) is determined not only by reference to the objective facts, but also by reference to the company s opinions and beliefs in respect of the objective facts. 35 In effect the information is 34 Jubilee Mines NL v Riley [2009] WASCA 62. 35 This proposition is supported by the decision in Jubilee Mines. See also our paper The Fortescue decision in the Full Federal Court, March 2011. As noted in that paper, Gilmour J in Fortescue at first instance considered that the question of whether the agreements were material and hence announceable under s674 depended on FMG s belief as to their effect. Gilmour J found that FMG genuinely believed the agreements were binding, and had reasonable 7

defined by reference to the company s perception of it (rather than by how someone else might characterise it). That is the information of which the company is aware. In this case, the joint judgment considered that FMG s statements that it had entered into binding agreements were statements of fact, albeit based on an intention the parties intended to enter into binding agreements so it was correct for FMG to say that it had done so. Obviously an intention is a state of mind, as is a belief or an opinion. In effect, the statement was correct as a matter of fact because FMG and the Chinese SOEs believed that they had entered into binding agreements they had said so to each other by signing the framework agreements. In the language of continuous disclosure, that was the information of which FMG was aware. On this basis, the High Court s decision tends to support the view that the information to be assessed for materiality is defined by reference to the company s perception of it. Where does this leave the Full Federal Court decision? The High Court referred to this passage from Keane CJ s decision in the Full Federal Court: 36 Once it is accepted that FMG s announcements contravened s 1041H of the Act, FMG, having made misleading statements to the ASX, was obliged by s 674(2) to correct the position. The High Court did not criticise this proposition but simply noted that its premise that FMG had made misleading statements was not established; that is, there was nothing to correct. Where this leaves the above statement is unclear, but as we have previously discussed (see our paper The Fortescue decision in the Full Federal Court ) in our view it cannot be taken to mean that whenever a company makes a misleading statement on a material matter which it does not immediately correct, the company also breaches its continuous disclosure obligation in short, that can only be the case if the company is aware that its statement was misleading. Keane CJ also found that Forrest was personally liable for involvement in FMG s misleading and deceptive conduct and continuous disclosure breaches, and breached his duty of care and diligence under s180 of the Corporations Act by failing to prevent FMG s misleading and deceptive conduct and continuous disclosure breaches. As noted in our paper The Fortescue decision in the Full Federal Court, it is unclear whether Keane CJ considered it sufficient to establish Forrest s involvement as being constituted merely by his knowledge of the terms of the framework agreements, or whether his involvement was founded on a lack of belief by him in the binding effect of the agreements in our view the latter reading is the better reading. 37 Finally, Keane CJ considered that Forrest could not rely on the business judgment rule in s180(2) in relation to the claim that Forrest was in breach of his duty of care and diligence by failing to prevent FMG making a misleading announcement. His Honour considered that grounds for that belief, so the agreements were material and it was hence appropriate for FMG to announce them. In other words (not Gilmour J s), the information to be assessed for materiality is the information in the eye of the beholder, the beholder being the company. This approach was essentially supported by Heydon J s decision, who said (at [76]): Low though ASIC's esteem was for the agreements, if Fortescue had said nothing about them it would probably have been in breach of the ASX listing rules. Heydon J, like Gilmour J, accepted that FMG genuinely and reasonably believed that the agreements were binding. Hence FMG s belief (as to the binding effect of the agreements) formed part of the information of which was aware and which made the information (the entry into the agreements) material. 36 [2011] FCAFC 19 at [189]. 37 This reading is supported by Heydon J s judgment in the High Court (at [98]): The trial judge found that there was no basis for ASIC to assert dishonesty on the part of [Fortescue], its board and in particular, [Mr] Forrest." The Full Court did not expressly overturn that finding. It did, however, point to some efforts of Mr Forrest, both in an internal email of 27 October 2004 and in dealings between Fortescue and CREC, to achieve particular results through an "Advanced Framework Agreement". It also pointed to CREC's response. The Full Court suggested that these facts revealed "subjective beliefs" of Fortescue and Mr Forrest which were inconsistent with a belief in the contractual character of the agreement. 8

the existence of specific exculpatory provisions in s674 referable to officers the due diligence defence in s674(2a) meant that the business judgment rule was not available in relation to a breach of s180. Since the High Court did not need to explore these issues, the lack of clarity in Keane CJ s judgment could contribute to an ongoing divergence of views in the legal and regulatory community as to the correct approach to these issues. For further information please contact: JOHN KEEVES Partner T +61 2 8274 9520 john.keeves@ DAMIAN REICHEL Partner T +61 2 8274 9530 damian.reichel@ Important Disclaimer: The material contained in this article is comment of a general nature only and is not and nor is it intended to be advice on any specific professional matter. In that the effectiveness or accuracy of any professional advice depends upon the particular circumstances of each case, neither the firm nor any individual author accepts any responsibility whatsoever for any acts or omissions resulting from reliance upon the content of any articles. Before acting on the basis of any material contained in this publication, we recommend that you consult your professional adviser. Liability limited by a scheme approved under Professional Standards Legislation (Australia-wide except in Tasmania). 9