Judge warns two-hatted directors of conflict risk

The prosecution of Nathans’ Finance directors demonstrates the problems associated with wearing two business hats, according to trial judge Justice Paul Heath.

At a closed-door session on corporate governance this week, Justice Heath told legal, regulatory and corporate heavyweights the conflict also led to a fundamental misunderstanding of the directors’ obligations when issuing a prospectus.

He said a defence to a charge of issuing a prospectus containing a misleading statement is that the director honestly believed on reasonable grounds that the statement was true.

“Yet, throughout the [Nathans’] trial, the directors’ focus seemed to be on whether each had an honest belief on reasonable grounds that VTL [Nathans’ parent company] would succeed,” the judge said.

“There is a disconnect between the two questions.”

“A director could have had an honest belief that the parent company, to which moneys were being advanced, would succeed and, ultimately, repay the debt without holding an honest belief on reasonable grounds that the statements made to members of the public in the relevant prospectus were true,” he said.

After a lengthy trial Justice Heath last year found Nathan’s directors Roger Moses, Mervyn Doolan and Donald Young guilty of misleading investors. Director John Hotchin earlier pleaded guilty and gave evidence against his business associates.

Justice Heath said the Nathans’ prosecution revealed a stark conflict of interest which blinded the directors from seeing and understanding the impact of their decisions on those who invested money in Nathans.

He said the conflict arose out of their common directorship in parent company VTL.

VTL carried on an entrepreneurial business, while Nathans’ was a finance company taking deposits from members of the public.

“Members of the public were entitled to believe they could rely on Nathans’ directors to deal prudently with the money they had invested.

“Instead, because of their unswerving belief in the VTL business model, the directors of Nathans’ were prepared to continue lending significant sums of money to VTL in the face of cogent evidence that they might not be repaid,” Justice Heath said.

He said that while, in larger companies, directors will delegate management responsibility to executives, the board retains responsibility for providing strategic direction and supervising the way in which its directions are carried out.

He said it would be wrong for the board to focus only on supervisory functions because it also has the obligation of setting policies to be implemented by management.

He said a focus on supervision or management “presupposes that the business drive comes from the managers of a company and that the board is there primarily to keep them on the rails”, whereas is it “for the board, representing the interests of those who appoint them, to set the standards which they expect from managers and to set them high”.

What other legal experts said

In a lengthy analysis of the key lessons learned from the Nathans, Lombard and Bridgecorp collapses, lawyers David Jones, of Jones Young and Cathy Quinn, chairwoman of Minter Ellison Rudd Watts, concluded the three cases made an interesting contrast.

“In Lombard, the directors [Sir Douglas Graham, Lawrie Bryant, Michael Reeves and Bill Jeffries] had a substantial degree of diligence in relation to the offering documents and governance.”

“In Nathans, they didn’t.”

“In Nathans [John Hotchin, Roger Moses, Mervyn Doolan and Donald Young] it was a case of affirmative statements made which were held to be misleading.”

“In the case of Lombard it was a case of what wasn’t said.”

“In Bridgecorp [Bruce Nelson Davidson, Rod Petricevic, Rob Roest, Gary Urwin and Peter Steigrad] it was a case of affirmative statements and omissions.”

“In Nathans, the contrast between the truth of the statements made and the reality was stark.”

“In the Lombard case, the omission was marginal.”

“In Nathans and Lombard, the directors were held to have had an honest belief in the truth of the statements but considered by the Courts to be not reasonably held.”

“In Bridgecorp the directors were held not to have a reasonably held belief.”

Corporate governance sessions, organised in both Wellington and Auckland by the New Zealand Law Society’s continuing legal education programme, were deemed necessary in the wake of a number of issues of director accountability and duties raised by a handful of financial company directors’ trials and the collapse of more than 60 finance companies from 2006.

The law society banned the media from attending the sessions, partly, NBR ONLINE was told, on the grounds participants might be mis-reported during question-and-answer or panel sessions.

This story is based on a limited number of papers released to NBR ONLINE by the law society.