The Federal Court’s recent decision in the Pesaka Astana bonds case has rattled the bond market.
Last month, the court ruled inter alia that the lead arranger (KAF Investment Bank Bhd) for the RM140mil bonds issued back in 2004, had rightfully excluded liability relating to the veracity of information contained in the information memorandum, according to court documents.
Info memos are essentially the sales brochure about an investment product such as bonds, that are sent to investors, typically institutional funds.
“Investors rely heavily on what’s provided for in the info memo, expecting at least that the info is accurate and verified by the principal advisor.
“That has been the market convention for the longest time,” says a fixed income fund manager with a local bank who declined to be named.
But in its recent decision, the Federal Court set aside the High Court and Court of Appeal decisions of apportioning liability between the trustee (Maybank Trustees Bhd) and the lead arranger KAF.
The Federal Court held the view that KAF was entitled to exclude liability of what is stated in the info memo.
One of the key reasonings cited by the Federal Court was that bond holders were “sophisticated investors with vast experience in the capital market. They are no ordinary investors”.
Citing English case law, the Federal Court said the burden of verifying the content of the info memo was on the potential investors rather than KAF.
“The judgement is a landmark case because it raises the traditional ‘caveat emptor’ principal to a new height. It is left to be seen how the capital market will digest this,” says a senior lawyer.
Fund managers say one result of this decision is that it may affect the efficiency of the market. “This means that as an investor, you now have to do a full blown due diligence on the issuer. The info memo can’t be relied on. So you could have a situation of say 50 different funds as potential bond investors, visiting and studying the issuer to get all the basic facts,” says a fund manager.
Adds a senior lawyer: “There is also a cost issue. The resources, time and costs involved in appointing professionals to verify the data in the info memo would now fall on investors.”
In addition, there is the issue of access to information.
“Some issuers are private companies and information on them isn’t easily available,” the lawyer added.
He reckons all this would nudge investors away from investing in corporate bonds, especially for debt papers issued by smaller, lesser-known companies.
On the flip side, there are those who agree with the principle that those who prepare the info memo should be entitled to exclude liability.
“In the spirit of caveat emptor, as long as those who prepared the info memo acted in good faith, they should be excluded from liability,” says Mohd Razlan Mohamed, the CEO of Malaysian Rating Corp Bhd (MARC).
He declined to comment on the specifics on the Pesaka Astana bond case, but says as a matter of principle, fund managers can’t expect too much out of the info memo.
“Every fund manager has to do his own checks.
“The info memo is just one piece of guidance,” he says.
“Investors can also use other documents like credit rating reports and public documents to base their analysis to derive at an informed investment decision.
“Every investment comes with risk. Investors should price in the credit risk premium adequately that meet with their risk tolerance and risk- reward scenario,” he adds.
When asked if the efficiency of the bond market is going to be impacted he replied: “It’s not just a case of efficiency but also of efficacy. Fund managers by their mandate have to be effective in playing their role and not just buy products blindly based on something like an info memo.”
He said that if and when an info memo was inaccurate, it merely reflected on the credibility of the issuer and its advisors. “Info memo’s are not to be taken as a guarantee or warranty of the said products,” he enthuses.
Relevancy of securities laws in question
At the heart of the matter also lies a provision in Malaysia’s securities laws that regulates exclusion clauses in investment-type documents.
According to section 256 of the Capital Markets and Services Act 2007(CMSA), (previously section 65 of the Securities Commission Act or SCA 1993), an agreement is void if it attempts to exclude civil and criminal liability stemming from other sections in the CMSA.
Notably, the other sections in the CMSA referred to relate to the making of false and misleading statements or having material omissions or if the statements are tantamount to deceptive conduct.
So an issuer or its advisor isn’t allowed to exclude such liability on documents such as the info memo.
Notably, the High Court had decided that KAF’s duty as the lead arranger for the Pesaka Astana bonds, was to also verify the information that was given by Pesaka Astana against the original documents.
The court held that in failing to do so, KAF was negligent.
The Court of Appeal had affirmed the decision of the High Court, adding that KAF could not contract out its statutory duties or liabilities as it contravened section 65 of the SCA (now section 256 of the CMSA).
The Federal Court disagreed with both reasonings.
It said that it did not know what was the basis for the High Court to impose a duty on KAF to verify the information contained in the info memo.
The Federal Court also said that Section 65 of the SCA only dealt with agreements entered into two parties and that the info memo is not a contractual document.
“It had been issued on behalf of Pesaka to provide information to potential investors.
“The info memo was not part of the issue documents which requires the approval of the Securities Commission (SC).
“For those reasons, we hold that the info memo is not an agreement falling within section 65 of the SCA, therefore, KAF is free to include the important notice (exclusion clause) in the info memo to exclude any liability arising from any claim that may arise from the info memo,” the Federal Court stated in its judgement.
It should be noted that under the CMSA, info memo’s that are lodged with the SC are taken to have the same liability as IPO prospectuses.
But going by the Federal Court decision, it raises the question of whether section 256 of the CMSA 2007 is now irrelevant as the decision enables issuers and their advisors to exclude their liability.
It is left to be seen if this new ruling will apply to IPO prospectuses.
Whatever the case, it looks like the caveat emptor principle has just been given a massive shot in the arm. But industry observers reckon that this could come at a price to the attractiveness of the Malaysian private debt market.