Sons of Gwalia Ruling Has Opened Pandora’s Box

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MELBOURNE AUSTRALIA 1 February 2007 – Taking a slight step back from the markets, we stop to consider the implications of yesterday’s ruling in the High Court concerning the collapse of Sons of Gwalia, that decreed in certain circumstances, shareholders (and therefore the owners) of a company can stand on a par with other creditors in the event of a company being wound up or going bust.

Traditionally, shareholders of a publicly listed company have been at the back of the queue when it comes to divvying up the last remaining pennies.  Now however, with this decision it has the potential to turn the investment markets on their proverbial heads.  But does it make sense?

First of all, to what extent should an investor be protected with his/her investment against the venture going pear-shaped?  Arguably, the answer should be that there should be no protection.  Part of the reason why shares – on average – produce higher returns than cash is because share ownership involves taking on a higher level of risk than investing in a bank account.

In other words, can we expect to see the expected rate of return on shares fall as the potential losses from a share investment are suddenly – even if it is only marginally – lower than previously.

Also, at what point does the compensation or right to sue become applicable?  Is it just when a company goes bankrupt?  Or can it just be when a company releases a worse than expected profit result which causes the shares to fall and investors to lose money?

Conversely, what happens to those investors that have short sold shares?  Can they now sue the company if the profit result is higher than expected, causing shares to rise and the short sellers to lose money?  Where will it all end?  Apart from in the lawyers pockets.

But is it the company that the aggrieved shareholder should be suing?  What about the shareholder who sold their shares on the market.  Could they be liable as well?  After all, unknowingly passing on stolen goods is still punishable, could unknowingly selling shares in a company that was later found to be insolvent become a punishable offence?

Of course the positioning of the Australian Securities Exchange and the Clearing House between all share transactions removes any direct transfer of ownership, so perhaps the ASX will become the focus of litigation for allowing these transactions to proceed without having conducted proper due diligence on the company in question.

It also makes the whole legal process rather difficult as well.  Who exactly is the aggrieved shareholder suing?  If he/she is still the owner of the stock then in effect they are partially suing themselves as a part owner (shareholder) of the company.  Plus, who is eligible to sue?  According to the report from News Ltd, only those shareholders that bought Sons of Gwalia shares in the market during the specific period are eligible to sue.

What about the other shareholders?  Have they been any less deceived than the others.  Perhaps we can assume from this decision that the courts believe the SofG shareholders that we existing shareholders were part of the conspiracy to cover up the truth.

But, whatever the nuances of the decision in the High Court it is plainly a daft decision that will reap absolutely no benefit to anyone, except the aforementioned lawyers.  Companies that wish to deceive their shareholders will continue to do so and will only succeed in finding ever more elaborate ways of doing so.

It seems to your correspondent that the High Court has taken a massive and ill-advised step outside of their realm of expertise and opened a veritable Pandora’s box of worms.

Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.
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