New Zealand's first representative shareholder action: Negligent, false and misleading statements in prospectuses and the 'notional investor'. Houghton v Saunders - DAC Beachcroft

All Collections

Sort By

New Zealand's first representative shareholder action: Negligent, false and misleading statements in prospectuses and the 'notional investor'. Houghton v Saunders's Tags

Tags related to this article

New Zealand's first representative shareholder action: Negligent, false and misleading statements in prospectuses and the 'notional investor'. Houghton v Saunders

Published On: 11 December 2014

The failure of New Zealand's first representative action shareholder claim in Houghton v Saunders [2014] NZHC 2229 may deter further class action type proceedings, while giving better guidance on the standards of care owed by company directors. We examine the collapse of the Feltex group, the claim brought and the impact on its directors.


Feltex Carpets Limited ("Feltex") issued a combined investment statement and prospectus to make an initial public offering ("IPO") in 2004. The share price was $1.70. By September 2006, Feltex’s bank had appointed receivers and the shares were worthless.

Mr Houghton, in a representative action for all the shareholders, commenced proceedings in the New Zealand High Court against the former directors of Feltex who participated in the IPO. The claims alleged: 

  1. The prospectus contained statements that were untrue and in breach of the Securities Act 1978 ("the Securities Act");
  2. Parts of the prospectus were misleading and omissions from the prospectus left a misleading impression overall in breach of the Fair Trading Act 1986; and
  3. There had been a breach of duty of care in tort, because the misstatements in the prospectus and a public announcement were negligent.

On 15 September 2014, Justice Dobson cleared the former directors of Feltex of any liability for the alleged failings of the 2004 prospectus and IPO.

Securities Act Claim

The Court held that, although a number of the plaintiff’s criticisms of the prospectus had some justification, none of them made out material misleading content or omissions that would trigger liability under the Securities Act.

Assessing the Prospectus

The statutory test requires a plaintiff to identify the passages from the prospectus that are alleged to address a materially misleading term. Where allegations relate to omissions from a prospectus, a plaintiff must identify a particular statement that is considered misleading because of the omission of additional information. That additional information must be material to understanding the alleged misleading statement. Accordingly, a plaintiff cannot plead that the impression of the prospectus as a whole is misleading. This objective standard is to be applied by reference to the “notional investor”. 

The “notional investor”

The Court stated that the “notional investor” is a prudent but non-expert person who has at least a basic understanding of all the narrative content of the prospectus. Prudently he or she will not invest in the company before seeking clarification on passages not understood and perceived as material. Justice Dobson noted there will be exceptions where such an investor does not appreciate that he or she does not understand particular misleading content and proceeds in reliance on that misunderstanding.

Reliance Required to Trigger Liability

Under the Securities Act the plaintiff is required to prove that he or she subscribed for shares “on the faith of” a prospectus containing an untrue statement or omission. The Court concluded that a plaintiff therefore has to prove that the misleading content or omissions were material to the decision to invest. That is, if the misleading content or omission was corrected, more likely than not, the investment would not have been made. 

Promoters Under the Securities Act

The fourth and fifth defendants were brought in as promoters of the prospectus under the Securities Act. However, the Court found their involvement did not go beyond that customarily assumed by joint lead managers. That is, they were both acting as professional advisors rather than an entity which was instrumental to the IPO plan or programme (a promoter).

Fair Trading Act Claim

Justice Dobson held that, because the relevant conduct was regulated by the Securities Act, no liability arose under the Fair Trading Act.

Negligent Misstatement Claim

The Court found that the relationship between the directors and other defendants on the one hand, and investors in the IPO on the other, did not give rise to the prospect of a duty of care in tort being imposed.

Due Diligence Defence

Finally, the Court held that the defendants had reasonable grounds to believe, and did believe, the truth of the challenged statements in the prospectus. Justice Dobson noted that a robust and thorough due diligence process was undertaken in compiling the prospectus. It followed the defendants would have been able to rely on a statutory due diligence defence had any of the claims been successful.