The guilty verdict for three Nathans Finance directors – Roger Moses, Mervyn Doolan and Donald Young – is a huge wake-up call for directors of public issuers.

That is because Justice Paul Heath has determined that “directors have a non-delegable duty to form their own opinions” on matters relating to investment statements, prospectuses and advertisements.

Justice Heath believes that the Nathans directors “purported to delegate to senior management the task of determining whether the investment statement and prospectus were ‘compliant’ with the regulatory requirements, and failed to bring independent minds to bear on the topic”.

The judge believes directors must make their own decisions; they cannot delegate important decisions to management, legal advisers, auditors, the trustee or the Registrar of Companies.

Justice Heath said that the Nathans directors seemed to place particular reliance on the company’s solicitors, Minter Ellison. He wrote: “Any such reliance was misplaced. Minter Ellison provided advice based on primary facts given to them by the client.” There was no evidence that Minter Ellison was given full updated financial figures after the June 2006 year annual accounts.

The Nathans decision is a ground- breaker because a large number of court decisions over the past 20 years have dismissed charges against directors because the directors acted on the advice of management or their professional advisers.

Justice Heath has clearly swung full responsibility back to directors.

The Nathans Finance story began in November 2000 when Vending Technologies, which subsequently changed its name to VTL Group, listed on the NZX after the sale of shares to the public at $1 each.

The post-listing shareholders were John Hotchin and Mervyn Doolan with 33.2 per cent each, Gary Stevens and Roger Moses with 4.1 per cent each and the public with 25.4 per cent.

VTL’s original directors were Richard Janes (chairman), Doolan, Hotchin and Elizabeth Coutts.

Hotchin was executive director of operations and Doolan the chief financial officer.

The prospectus said VTL “was established to acquire, manufacture and sell vending machines for convenience foods and to manage and service these machines”.

In July 2001, VTL established Nathans Finance as a fully owned subsidiary. It had no connection with the well-established Auckland business family, but the name gave the impression the finance company had been around for a long time.

The original Nathans directors were Janes (chairman), Doolan, Hotchin and Warrren Larsen, the former chief executive of the New Zealand Dairy Board.

Janes and Larsen resigned at the end of 2002. Moses joined the board in 2003 and Young in 2005.

VTL beat its profit forecast for the first two years, but the June 2003 year result showed the company was beginning to struggle. It had converted itself from an owner and operator of vending machines in Australasia to a franchisor, mainly in Australia and the United States.

Nathans had become VTL’s funding arm, supplying most of the funding for VTL’s machines and for purchases by its master franchisees.

This business system was an abject failure and Nathans Finance was placed in receivership on August 20, 2007. VTL suffered the same fate on November 5, 2008.

The receivers’ report showed that Nathans had assets of $194.5 million on the day of receivership of which $165.7 million or 85.2 per cent was lent to VTL, master franchisees or on other machine loans. A further $3.7 million was lent to related parties of the directors.

Only a tiny fraction of this $169.4 million has been recovered.

VTL reported a loss of $133 million for the 14 months to August 2007, which had a direct impact on recoveries by the finance company.

Nathans investors have received only 3.7 per cent of their money back and any further returns will be dependent on legal claims against the directors and auditors.

The Crown charged three Nathans Finance directors – Moses, who was chairman, Doolan and Young – with six counts under section 58 of the Securities Act 1978. One was in relation to an investment statement, two related to prospectuses and three related to advertisements or letters sent to investors.

One of the charges relating to an advertisement was dismissed because the letter was not deemed to be an advertisement.

One interesting aspect of Justice Heath’s judgment was the role of the Securities Commission and the conflict between full disclosure and the effect this could have had on Nathans’ ability to raise money from the public.

The finance company received a letter from the commission in March 2006 about the inadequate disclosure of risk, particularly the proportion of Nathans’ funds loaned to VTL and other related parties.

Nathans replied that “the directors were at considerable pains to disclose the significance of the inter-group lending without being completely specific as to the quantum given that it would fluctuate over time”.

Justice Heath reported that Nathans’ internal lawyers “advised the VTL directors (but not Young) that the commission did not propose to take any further action”.

A few months later Nathans’ internal lawyers advised that the inter-company indebtedness, which amounted to 46.2 per cent of assets, should be disclosed in the new prospectus.

The response from directors reflected the tension between full disclosure to the public and the commercial imperative of “selling” the offer to the public.

Moses said that the increased disclosure requirements were “tough” and Hotchin, a director who has pleaded guilty to similar charges faced by the three other Nathans’ directors, responded from the United States: “I strongly urge that the RISK section is changed as if this is going to market NO cash will come in (Hotchin’s emphasis)”.

How many other failed finance companies had inadequate disclosure because directors were afraid full disclosure would restrict their company’s ability to retain existing funds and raise new money?

Why did the Securities Commission not continue to pursue Nathans when it had determined the company had inadequate disclosure?

Justice Heath found the three directors guilty because he was “satisfied that statements made in both the investment statement and the prospectus were material and misleading”.

He said that it was “the combination of statements and material omissions that conveyed a false impression to investors about the true nature of Nathans’ business, the actual state of its financial health and the risks of the investment”.

The judge made several important points, including:

* Loans to VTL companies were supposed to be repaid within 12 months but were consistently rolled and with interest capitalised. This was not disclosed to investors.

* The Nathan directors knew the VTL loans could not be repaid out of revenue; they could be repaid only if VTL sold all or some of its business units.

* Statements about good governance and robust credit management were far from the truth.

* Loans to trusts associated with Doolan, Hotchin and Stevens were made without any inquiry as to the capacity of the trustees to repay them out of trust assets. These loans have not been repaid according to the April 2011 receivers’ report.

Justice Heath’s 156-page judgment is a fascinating read as it shows the Nathans’ directors were hopelessly conflicted, their decision-making processes were poor and disclosure to investors was inadequate.

Most of the failed finance companies had some or all of these characteristics. The many upcoming court cases for these companies should be extremely revealing in this regard.