Earnings guidance is a difficult topic for public listed companies. ASX devotes 25 pages of Guidance Note 8 (continuous disclosure) to earnings guidance and what ASX considers to be acceptable practices in relation to providing the market with earnings guidance, and how to deal with what ASX refers to as an ‘earnings surprise’.
In a typical situation, a listed company will state that it expects its earnings for the next reporting period to be similar to the last one. Before doing so, the company will undertake appropriate due diligence and as ASX recommends, the underlying figures and assumptions are carefully vetted and signed off at a suitably senior level before the guidance is released. If before the next results are issued there is a material variation in the forecast, the company updates the market and explains what has changed. This is what happened in the circumstances that have led to the first successful shareholder class action in Australia.
Crowley v Worley
On 11 March 2022, an appeal was granted by the Full Court of the Federal Court of Australia in the case of Crowley v Worley (2022) FCAFC 33.
In brief, Worley Limited (Worley) announced net profit after tax (NPAT) of $322 million for FY13. On a number of occasions between August and October 2013, Worley gave guidance that FY14 would result in increased earnings. This guidance was based on an internal budget of $352m NPAT. Then on 20 November 2013 Worley announced a revised NPAT forecast of between $260 and $300 million. This resulted in a 26% decline in Worley’s share price. Mr Crowley and other shareholders brought a class action claiming they suffered loss resulting from the failure by the company to comply with s 1041H of the Corporations Act and the Competition and Consumer Act (misleading and deceptive conduct), and ASX Listing Rule 3.1 and s 674 of the Corporations Act (continuous disclosure).
The Full Court found that Worley may not have had reasonable grounds to make the initial forecast. The court pointed out (as ASX does in GN 8) that as a forward-looking statement, earnings guidance is a representation as to a future matter – and under s 1041H of the Corporations Act and other legislation, the representation is taken to be misleading if a person does not have reasonable grounds for making it. Having regard to a document entitled the ‘Holt memorandum’ (which was written by the CFO of Worley, Mr Holt, as part of an internal investigation into the guidance failure), the court was of the view that Worley knew or ought to have known that the forecast might be inaccurate. Management was aware that the original forecast would likely have been optimistic: the court referred to there being a ‘culture of optimism’, and the fact that the board may not have been aware that the budget was optimistic did not absolve the company from liability.
The court further considered the ASX Listing Rules and the definition of ‘information’ pursuant to s 674 of the Corporations Act, and held that an opinion – even one that has not yet been formed but however should have been formed – is information that must be disclosed under a company’s continuous disclosure obligations, and if not disclosed can expose the company to liability for damages.
The key takeaway from this full Federal Court decision is confirmation that shareholders have rights against companies that issue misleading guidance or do not comply with their continuous disclosure obligations. Further, companies need to be particularly careful to undertake appropriate due diligence (and retain records of having done so) before issuing earnings guidance. The due diligence should include close examination of key management personnel to ensure there is no disconnect between information, including opinions, available to management and the board.
Michael Wilton (Partner) and Matthew Emmerton (Trainee Lawyer)
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