regulators using information both ways

  • Date:01 Sep 2005
  • Type:CompanyDirectorMagazine

Regulators using information both ways
Can information gathered by regulators be used both for criminal and civil proceedings

In last month’s Law Reporter we commented on the problems faced by the Australian Securities and Investments Commission and the Director of Public Prosecutions in deciding how to “pursue” Steve Vizard for alleged breaches of the law which carried criminal sanctions.
Under the Memorandum of Understanding (MoU) between ASIC and the DPP, as was noted in last month’s discussion of a different scenario involving ASIC and One.Tel director Jodee Rich, arrangements between ASIC and the DPP (given government blessing), create significant difficulty for ASIC if it wishes to pursue matters civilly and criminally once the relevant question has become one for the consideration of the DPP. But the difficulties do not only arise in the context of the MoU.
There are legal problems as well that will arise as has been recently illustrated in the case ASIC v Rich & Ors (2005) 52 ACSR 374. This case involved a situation where, as is often the case, ASIC was uncertain as to which of the two avenues it should be adopting – pursing the defendant in a civil case, or in a criminal case. It has powers to gather evidence in relation to matters which may, however, be used both in the context of civil or criminal proceedings.
The question then arises as to whether the information, which had apparently been obtained by ASIC, presumably for use in criminal proceedings, can be utilised by the same regulator for civil proceedings (because criminal proceeding are regarded by ASIC as too difficult). As noted above, the recent litigation involving Rich and ASIC concerned these matters and we take the facts of the case from the LexisNexis (Butterworths) Corporations and Securities Reports.
The Australian Federal Police (AFP), at the request of ASIC, issued search warrants under the Commonwealth Crimes Act 1914, the premises owned by the company One.Tel and at the private residences of certain of One.Tel’s directors. Because the warrants concerned matters of financial relevance, ASIC retained PricewaterhouseCoopers (PwC) to assist in the execution of the warrants and to examine the relevant material. PwC staff who had been appointed to assist ASIC were described in the relevant documentation as “constables assisting” the relevant law enforcers. Documents were seized at various premises – both hard documents and electronic material which was downloaded or copied to storage devices.
At that time, ASIC had formed the view that it would probably be pursuing the matter on a civil basis. On 7 December 2001, the liquidators of One.Tel agreed that ASIC could retain the materials for the following purposes:
(1) investigating whether contravention of civil penalty provisions had occurred; and
(2) initiating and prosecuting civil proceedings against the relevant directors.
When the civil proceedings were commenced, Rich sought to have the evidence obtained through the raids excluded from the material that ASIC could use. He argued that the search warrants had been executed illegally. He also argued that the materials obtained under the search warrants had been provided improperly to PwC personnel. It was his counsel’s view that the purpose of obtaining the material was to conduct a criminal investigation. Therefore in his counsel’s view the material obtained could not be used in a civil proceeding. It was further argued that notwithstanding the fact that the liquidator had consented to ASIC using the information, this consent was ineffective because of the rules of procedure.
Austin J, in another major decision which he has made in a series of cases involving One.Tel and Rich, ruled against Rich on these particular points. While the judge agreed that the AFP had not been authorised to make available to the so called “constables assisting” matters that had been seized, it was possible for ASIC to have access to this material through the formal arrangements between the AFP and ASIC. In that context, ASIC could appoint PwC personnel as “ASIC officers” for the purposes of conducting various enquiries.
However, Austin J ruled that any materials obtained by ASIC for the criminal investigation could not be used for the civil proceedings in the absence of an effective consent. He examined a number of important cases involving the interaction of criminal and civil investigations. He concluded:

“ASIC could not use the search warrant material it obtained in the present case for the purposes of the present civil proceeding, were it not for the liquidator’s consent. The fact that, in the present case, the civil proceeding began well after the execution of the search warrants is immaterial, ...because the use of the search warrant materials for a civil proceeding whenever it commences is a use outside the purposes contemplated by the warrants. I see no relevant distinction between the civil proceeding in the present case and [certain cases upon which counsel is relying]. It appears from the cases that the search warrant materials cannot be used for a later civil proceeding even if those materials have been used for the purpose of a single investigation with criminal and civil elements prior to the commencement of the civil proceeding” (see para 262).
However, was the consent given by the liquidator’s sufficient to take this prohibition outside the reach of the cases referred to by Austin J? In the judge’s view, regulatory agencies such as ASIC would very rarely conduct an investigation solely for the purpose of determining whether a civil prosecution should be pursued. They will nearly always want to consider as well as whether a criminal offence arose from the facts. Austin J noted:

“In a case where there is a single investigation into civil and criminal contraventions, it may not be possible to sub-divide the investigatory thought processes into criminal and civil components and then treat them as mixed purposes.” (at para 261)
While the position might be different if the criminal and civil investigation functions were placed at the hands of different agencies, where the same agency was involved, as was the case here, the evidence should be able to be used by the regulator for both purposes. In his view, ASIC had not compartmentalised its investigation. He summed up:

“Reason and common sense suggest that a single investigation of a set of facts for suspected criminal and civil contraventions will often be the most efficacious way of gathering information to determine whether offences have been committed, while also determining whether civil contraventions have been committed. Therefore it is consistent with the purposes of the search and seizure provisions ... to allow the seized materials to be used in such investigations. The contrary view would entail splitting up the components of the investigation in a necessarily artificial way, at least in cases where (as here) there are civil and criminal provisions covering much the same subject area. It could lead to the complete separation of the criminal and civil components of the investigations, with inevitable inefficiency, cost and duplication of effort. There is no legal basis [in the relevant legislation] or from any general principle of statutory construction, that would lead to such an outcome.” (at para 270)
However, Austin J warned that it did not mean that such search warrant materials could always be used in this “double” way. He added that one could readily “envisage cases where the offences designated in search warrants are tacked on to an investigation which is essentially about other contraventions within another factual matrix. Instead, the kind of case I have in mind is one where there is such an overlapping and interrelationship between the criminal offences designated in the warrants and the other contraventions falling within the scope of the investigation, and the factual matrix to which the suspected criminal and civil contraventions relate, that the task of the investigators is to assess what of the evidence discovered about the whole matter under investigation reaches the criminal or only the civil standard” (at para 271).
Austin J then went on to cite a number of examples to illustrate the issue that was under consideration. It is useful, because these matters relate to the role of directors and the way in which they operate and may be investigated, to discuss some of these matters in this note. In particular, Austin J referred to the situation facing directors who might be investigated for breach of the insolvent trading provisions.
As readers will know, certain aspects of the prohibition against insolvent trading carry a criminal sanction. Others relate to a civil standard. In such circumstances, the investigation:

“Would consider the state of solvency or insolvency in the company at the time when debts were incurred, and matters going to whether there were at those times reasonable grounds for suspecting that the company was insolvent”.
Austin J went on to note that the investigations would relate to the position of individual directors and how they behaved in the context of the relevant facts. Some of those issues might go to questions of criminal liability, others to questions of civil liability, while most would go to both.
The investigators would be assessing these issues with respect to both the criminal and the civil sanctions. In such a case, Austin J concluded that the use of search warrant materials “is not improper because the investigation is directed to assessing whether the criminal or only the civil standard is met, upon assessment of the entirety of the facts” (at para 272).
He contrasted his description of the use of the material in relation to that aspect of insolvent trading to one where in his view, the material obtained by the regulator could not be used. This would be a case where, in addition to deciding whether insolvent trading had occurred, there was suspicion that a director may have misappropriated corporate property. There would be no overlapping of the factual matrices in his view in this situation, and the material seized could not be interchangeably used in relation to both civil and criminal prosecution.
As we find more and more regulatory regimes introducing both the civil and criminal set of provisions (as will occur in the context of the Trade Practices Act shortly) investigators will have a choice as to which of the two procedures they wish to concentrate on, questions of the kind raised in this case, and in other cases in which the interaction of ASIC and the DPP arise, will become more common.
Choices of this kind will need to be made by the regulator in the relevant scenario – whether it is the Australian Competition and Consumer Commission in the case of the Trade Practices Act, or other regulators such as APRA.
They will need to decide which route they wish to pursue. While the civil route will be easier to pursue because of the lower standard of proof required, and because, parties may be prepared to “broker” a deal (because they know they will not be going to jail), where criminal actions are being pursued and jail terms are at one “end of the road” the regulator will be pursuing, the relevant regulators will no doubt find arguments being raised more vigorously and seriously by defendants placed in a similar position to that faced by Rich
and other directors in similar situations. Tthey will try to limit
the use made by the regulator of the information obtained
through the relevant processes as well as raising other arguments to blunt the progress of the
Providing remedies for minority shareholders


Can litigation funding be used by shareholders in actions against directors?

One of the “classic” principles of Australian company law is that where a breach of duty is committed by a director (or directors) against a company, and losses are sustained by the company, the proper plaintiff to seek a remedy is normally the company.
But, over hundreds of years, the courts have recognised that in certain situations the company will be controlled by those who are alleged to have committed the breach. They will not want to sue themselves or their colleagues. Exceptions to the traditional rule were created (the so-called exceptions to the rule in Foss v Harbottle (1832)).
In 1999, as part of the “deal” struck by the Commonwealth Government and the business community for the introduction of a business judgment rule in relation to directors’ duties of care and diligence, statutory provisions were introduced to allow shareholders to sue company directors where the company refused to do so.
Section 237 of the Corporations Act, however, sets out a number of criteria which must be satisfied before a court will allow a shareholder to bring an action on behalf of a company. The so called statutory derivative action governed by this and other sections of the Corporations Act has not as yet been the subject of many decisions. Some of these have been noted in the pages of Law Reporter over recent few months.
The most recent example of a success for a shareholder in this area in Fiduciary Limited and Ors v Morning Star Research Pty Ltd and Ors (2005) 53ACSR 732. In that case, a Graham Rich, was one of the shareholders and owners of two companies known as Fiduciary Limited (Fiduciary) and Fiduciary Consultants (FC).
Rich had also formed another company, Morning Star Research Pty Ltd (MDU), which he said had been damaged by the actions of Fiduciary and FC. When these actions were commenced, they were brought by the companies Fiduciary and FC as well as by Rich.
At that time, the court ordered that the plaintiffs provide security for costs which they had failed or elected not to do. Rich then sought leave to bring a derivative action on behalf of himself and in the name of MDU. This company had not been made subject to the previous order allowing the action to proceed.
The defendants argued that Rich was not acting in good faith within the terms of s237(2)(b) of the Corporations Act.
Section 237(2) provides, among other things, that before a court should allow a statutory derivative action to be brought, it must be satisfied of the following circumstances:
(1) that the company is unlikely to bring the proceeding or to pursue them;
(2) s237(2)(b) that the applicant is acting in good faith; and
(3) it is in the best interest of the company that leave be granted.
There are other criteria that need to be satisfied but not for the purposes of this discussion.
In the case, the judge (Austin J again) had to decide whether Rich should be allowed to continue with this derivative action in his own name. Was he acting in good faith, and was the action likely to be in the best interests of the company?
Austin J also had to consider whether Rich could bring the actions because he had been an officer of a company which had nothing to gain from the particular litigation.
Furthermore, it appeared that Rich had entered into arrangements for funding to assist him in the litigation. The use of litigation funding is becoming a more and more relevant factor in our law.
Indeed in a further note in this month’s Law Reporter, we comment on a further case involving litigation funding in a case involving shareholders’ rights.
In the view of Austin J, Rich had established, on the basis of the information brought before the court, that he was acting in good faith.
In his view, when the court was faced with an applicant such as Rich, who had been a former officer of the company or companies involved, and who had nothing to gain directly by the success of the action, “the court will scrutinise with particular care the purpose for which the derivative action is said to be brought. Here, however, where the company is a joint-venture vehicle and the former officer is one of the venturers, and the application under s237 will allow him to assert those parts of the overall pleaded case in which it is contended that the company rather than the plaintiffs have suffered loss, and there is an obvious potential indirect gain to him in doing so, the question of collateral purpose has a different complexion” (see para 34).
The defendants argued that it was very difficult to see what, if anything, Rich had to gain by pursuing this case. On the basis of all of the facts, Austin J concluded that Rich had satisfied the standard required.
Was the action, however, in the best interests of the company?
The facts were complicated by the fact that the court was considering the claims of a joint-venture company. This is a case where one of the venturers “alleges that the other had acted unlawfully causing the company loss”. In those circumstances “it will usually be appropriate to allow the complaining venturer to bring proceedings [in the name of the company] against the other venturer and its representatives on the board, even though there are no other shareholding interests than those of the litigants and the effect of success of the litigation will be indirectly to benefit the complaining venturer proportionately to its shareholding” (at para 47).
The defendants argued that the company owned by Rich wasn’t in a position to finance any legal action. It had hardly sufficient working capital to operate its own business. And this raised doubts as to whether the legal action should be allowed to continue. Austin J, however, had been presented with evidence about this interesting set of facts:
“Given, however, the availability of litigation funding and the potential for recovery, to the ‘serious question to be tried’, the difficult financial circumstances of a company are not sufficient [of themselves] to warrant the conclusion that a proceeding should not be brought in its name.” (at para 48)
The judge then considered the question of security for costs. He accepted the arguments put forward by the defendants that security for costs should be ordered against the plaintiff in this case.
Austin J felt that the law drew a distinction between the position of the individual as a litigant and the position of a corporation. While an individual should not be barred from bringing proceedings because he/she is impecunious, in the case of a corporation it is appropriate to make an order for security as to costs.
The presence of litigation funding in cases of this kind, and the fact that the court was so willing to accept it as part of the background against which litigation of this kind may be pursued, makes it clear that we will see many more opportunities pursued by minority shareholders. These will be situations where, in the view of the shareholders, the directors have not been acting in the best interests of all of the shareholders, losses have been sustained by the company, and certain assertions might be pursued against the directors alleging breaches of duty and related matters.
The litigation scene in Australia is gradually changing. The complexities causes by the litigation funding and its greater and wider use unless this trend is countered by a High Court decision which is likely to be delivered in relation to the Fostif case (Early Warner, May).
Access to shareholders registry
Litigation funding is of no avail when access to share registry is for inappropriate purposes




In a separate note in this month’s Law Reporter I have commented on the use of litigation funding in relation to a statutory derivative action brought by a shareholder, in the name of the company, where that shareholder was a joint-venturer and was alleging loss sustained by him and his joint-venture company in the context of the running of the company’s affairs (see the previous note).
In another interesting, and quite different case, on questions relating to both litigation funding and also to the question of whether access will be available to the share registry of a company by litigation funders, the majority of the Full Federal Court has made it clear that use of litigation funding will be carefully reviewed in the context of claims which may be brought by such organisations.
Under s177 of the Corporations Act, access can be given to shareholders and members of the share registry of a company. There are strict restrictions on the utilisation of the information contained in the share registry and obtained by a shareholder or member. The relevant terms of the section (we need not set out the whole section, but only part of it) are as follows:

“(1) A person must not:
(a) use information about a person obtained from a register kept under this Chapter to contact or send material to the person; or
(b) disclose information of that kind knowing that the information is likely to be used to contact or send material to the person.” page 662
The section goes on to provide that the use of information inappropriately may amount to an offence of strict liability. Furthermore, any person who makes a profit from a contravention of this section will be deemed a debt to the company.
In the case of IMF (Australia) Ltd v Sons of Gwalia Limited (administrators appointed) (2005) 53ACSR 657, the issues raised for consideration of the Full Federal Court were quite important, not only in the context of s177 of the Corporations Act, but more generally in the context of litigation funding.
The facts are taken from the LexisNexis report of the case.
The plaintiff (IMF) a litigation funder, wanted to use information from the register of Sons of Gwalia to approach shareholders of that company with a view to commencing a group action against it. The defendant operated a gold mining business which had been placed into administration on 30 August 2004.
It was alleged that in the period immediately before the commencement of the administration the company had failed to disclose information about the level of its gold reserves. It was further alleged that some 40 million shares had been traded in that period. It was alleged that the shares were now worthless.
After the company was placed into administration, IMF applied to the administrators under s.177 of the Corporations Act to gain access to the register of members. The administrators refused saying it was not appropriate to provide this information to the litigation funder.
IMF challenged the refusal by seeking a declaration from the court which was refused in the first instance.
IMF then took the matter on appeal to the Full Federal Court, which confirmed the view of the judge at first instance and the view taken by the administrators, that access should not be granted.
While there were three members of the Federal Court sitting on this matter, it is the judgment of Emmett J which is perhaps the most interesting. He introduced his discussion of the matter by first tracing the history of the section and the way in which information obtained could be used. In his view, the relevant register and material contained in it should be related to the holding of the shares by the relevant shareholder in the company. He added these interesting observations (at para 63):

“An object of the [Corporations Act] is to create rights for compensation for shareholders and other persons who suffer damage as a result of contraventions of the Act. Accordingly s177(1) may not inhibit use of information in order to communicate with members concerning their potential rights, as shareholders, to bring or join in an action against a company for relief against oppression or to bring or intervene in a statutory derivative action. Such a use could be characterised as being for the purposes of communicating with a shareholder about a subject that is concerned with the fact that that person holds the shares in respect of which the person is registered. It might also be characterised as being the purpose of communicating a better subject that is connected with the exercise of rights attaching to such shares. However, it does not follow that a communication about the circumstances in which a person agreed to acquire shares in, or to become a member of, a company can be characterised as being connected with the fact that the person holds the shares in respect of which the person is registered all with the exercise of rights attaching to those shares.” (emphasis added by the judge)
In his view, the information that IMF wanted to obtain was for the purpose of prosecuting certain claims against the company and its directors.
In his view, the action taken to retain solicitors and to commence or prosecute the proceedings in relation to shares had nothing to do with the holding of exercising of rights attaching to shares. He did not believe that he was reading the section in a restrictive or negative fashion. While he agreed that the primary object of s177 was to prohibit the use of information obtained from a share register in order to engage in marketing activities, the proposals put forward by IMF could be regarded as very similar to a marketing venture.
The third (dissenting) judge in the case, North J reached a contrary view and ruled that access to the registry was available. An appeal is likely
This conclusion will be met with cheers in the boardrooms of many companies. It will perhaps dent somewhat the role of the litigation funders such as IMF. However, the final battle is yet to be fought in the High Court of Australia as we have commented upon in a separate note in this month’s Law Reporter.