Can boards hide their sensitive side?

A sensitivity analysis can be a useful tool for assessing the likelihood of meeting earnings forecasts. But are public companies bound to disclose that analysis to the market? The Full Court of the Federal Court of Australia has recently answered that question in the negative in a case in which JWS acted for the Respondents.

In Masters v Lombe (liquidator), in the matter of Babcock & Brown Limited (in liq) [2021] FCAFC 161, the Full Court looked at the materiality of information contained in a memorandum dated 13 August 2008 (Memorandum) which had been prepared by the then CFO and provided to the board of Babcock & Brown Limited (in liquidation) (BBL).[1]

Prior to the Memorandum, BBL had issued earnings guidance to the market. First, in its 2008 annual report published on 17 April 2008, BBL had forecast net profit after tax (NPAT) of at least $750 million ($750m Earnings Forecast). On 11 August 2008 (two days prior to the date of the Memorandum) BBL announced that its 2008 earnings were now “not expected to exceed 2007 Group Net Profit of $643 million” (Revised $643m Earnings Forecast).

In that context, the Memorandum, among other things, analysed the assumptions underlying the $750m Earnings Forecast. Adjusting for a probability weighted outcome, the Memorandum calculated likely earnings of $500 million and/or a range of between $400 million to $600 million. That was materially lower than both the $750m Earnings Forecast and the Revised $643m Earnings Forecast.

The Memorandum was considered at a BBL board meeting on 14 August 2008. The board agreed that no change was warranted to BBL’s earnings guidance based on the Memorandum, and in fact the Memorandum did not recommend any change to BBL’s earnings guidance given the uncertainty of a range of outcomes which informed the analysis.[2]

However, the appellants alleged that the figure for 2008 NPAT of $500 million in the Memorandum (“radically lower” than the Revised $643m Earnings Forecast) should have been disclosed to the market, and that a failure to make that disclosure constituted a breach of section 674 of the Corporations Act. [3] 

The Full Court rejected the appellants’ argument. Critically, the Full Court found that the Memorandum was a not intended to be used to make an assessment of earnings guidance. Rather, it was a sensitivity analysis or a “probability weighted assessment” of BBL’s earnings guidance.[4] Further, the Memorandum had:

…the character of a briefing paper bringing to the attention of the reader both analysis and information available at the time that might be used to make an assessment as to likely earnings… Viewed objectively, its content and form was not to state a conclusion or to express a forecast.  Rather, it invited discussion and the formation of an opinion by others based on its content concerning likely NPAT.[5]

The Full Court found that neither the Memorandum or the analysis within it was material information requiring disclosure under s674 of the Corporations Act.[6]

This decision ought to provide some assurance to boards that where a sensitivity analysis is conducted it may not need to be disclosed to the market. However, care should be taken in the manner in which the analysis is presented so as to distinguish it from a forecast.