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The Federal Court ruling on Feb 10, 2014 in the long-ongoing Pesaka Astana Sdn Bhd bond default case, absolving lead arranger KAF Investment Bank from blame, will make it tougher for smaller players to raise bonds, industry experts say.
This is because lead arrangers or managers can no longer be held responsible for details contained in the information memorandum (IM) which will affect smaller companies badly as their financials and reputation are not well-known, making it necessary for investors to rely on third party advice.
The ruling appears to be in contravention of Section 65 of the Securities Commission Act which restricts the exclusion of liability of arrangers under some circumstances. Parties are not allowed to seek exemption for losses under Section 55, 57 and 58 of the Act.
Section 55 specifically prohibits any statement that is false or misleading or one where there is a material omission of facts. Section 57 says a person who acquires, subscribes for or purchases securities and suffers loss or damage as a result of any statement or information contained may recover the amount of loss from all or any of the persons set out in the Act. There is a long list of such persons which clearly includes arrangers.
Section 58 does not make it an offence to provide misleading information but if another person relied on this information, then it is possible for him to claim for any losses incurred as a result of the reliance.
One industry source said that under the circumstances the Securities Commission (SC) is likely to be forced to close off the loopholes created by the ruling which may mean new legislation. The SC is understood to be studying the matter.
The SC had specifically introduced such legislation to ensure that arrangers and issuers were held to high standards when it comes to issuing bonds. This was part of the SC’s move to deepen the financial sector and give smaller companies better access to bond markets.
In overturning the decision of both the High Court and the Court of Appeal, the Federal Court has reversed what was originally hailed as a landmark decision as it set a firm guide on the expected standard of behaviour of the various players in the bond market.
The Federal Court found that the IM is not an “agreement” in the context of Section 65 of the Act but is a document issued by Pesaka. It overturned the decision of the lower court that had determined that in a bond default case, the lead arranger and the trustees are as equally liable to investors as the issuer of the bonds itself.
The initial decision was also significant says one expert, because very often the issuer cannot afford to pay the compensation that is due to the investors. However the independent advisors often do have that capability.
However the Federal Court ruled that the lead arranger was not liable for the information in its IM as it had added a disclaimer in the form of an important notice.
This latest decision however has raised concerns on the possible implications on Malaysia’s bond market.
One industry expert highlighted that with seemingly limited protections and options for recourse should there be a default, investors might be spooked from investing in bonds.
“Not only does this important notice excuse the lead arranger from liability, it also seemingly removes any duty of care or need for due diligence in verifying that the information in their IM is not false or misleading – the burden falls to potential investors,” he said.
He adds that it would also appear, that even if the lead arranger did indeed know that the information was misleading, it would still be exempt from liability by virtue of the important notice or disclaimer.
Meanwhile a corporate lawyer noted that as this judgement is likely to set a precedent, bondholders in general will not have many options in any bond schemes they have participated in should there be a default stemming from false, misleading or omitted facts.
But it is not just the investors that stand to be affected said the industry source, as smaller companies will also be hurt if investors start to shy away from the bond market. “It is not hard for a large companies or listed companies to sell its bonds, but for the smaller Sdn Bhd companies getting investors to take up their bonds may become a challenge,” he explained.
It remains to be seen if the 10 institutions or MTB will appeal the decision.
The question now seems to shift to whether the Securities Commission (SC) will act to revise or amend the current act to close this loophole. Nonetheless any new or revised act will be prospective in nature and will not protect investors who have participated in bond schemes before it is enacted.
To recap, the Pesaka Astana (Pesaka) case began in 2005, when the initial lawsuit was brought by 10 Malaysian financial institutions against the company after it defaulted on bonds it had issued a year before.
Uniquely the institutions also named the lead arranger, KAF Investment Bank (KAF) and the trustee Maybank Trustee Bhd (MTB) in the suit.
The 10 institutions are MIDF Amanah Investment Bank Bhd, CIMB Bank Bhd, Arbar Discounts Bhd, Avenue Invest Bhd, Bank Mualamat Malaysia, CIMB Aviva Assurance Bhd, Malaysian Assurance Alliance Bhd, SIBB Bhd, Universal Trustee (M) Bhd and BHLB Trustee Bhd.
In 2008, Pesaka agreed to a consent agreement in favour of the bondholders. While the independent advisors chose to go trial, which continued until mid-2010 as a result of various actions and counter claims by the parties involved.
The case centred around the the bondholders argument that KAF’s IM was false and misleading and that MTB had failed in its due diligence to ensure that it became the sole signatory of the designated accounts into which Pesaka was to deposit funds to be used as repayment to the bondholders.
In bond exercises, the IM is a document containing information that is given to prospective investors that contains information about the issuing company – in this case the document was compiled by KAF.
Designated accounts meanwhile are opened by the issuer to deposit funds that will be eventually used to pay back bondholders. In this case MTB as the sole trustee was tasked with taking control of these accounts by becoming its sole signatory so only they could approve fund transfers – a practice which is commonly known as ring fencing.
At the High Court level, presiding judge Justice Mary Lim found that the independent advisors had indeed failed in their duty. As the investment institutions had relied on the IM produced by KAF to make their investment decision and that MTB had failed at ring fencing the accounts.
Bondholders were awarded RM149 million and liability was divided as 60% to KAF and 40% to MTB.
The decision was then upheld by the Court of Appeal, which ruled that the details contained in the KAF’s IM was indeed questionable and the MTB had not shown the necessary care and diligence in ensuring that it was in control of the designated accounts.
The Court of Appeal however decided that liability should be split 50-50 between KAF and MTB.
In January 2013 the case was heard by the Federal Court, which reserved judgement up until February 2014 (13 months).
In its ruling, it disagreed with the lower courts saying that KAF could not be held liable as it had included an Important Notice in the IM – which served as a disclaimer over the details in the IM. Furthermore it was also decided that KAF could not be held responsible for MTB failure to take control of the designated accounts.
Instead the five man bench ruled that the fault fell solely to MTB, for failing to ring fence the accounts in the first place.
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