The curious ethics of corporate Ireland

The mammoth judgment of Ms Justice Mary Laffoy in the Fyffes v DCC case raises serious questions about corporate governance. • How could information about three months trading not be price sensitive at all and information about four and a half months trading be massively price sensitive? • How, if Jim Flavin of DCC acted unlawfully, as Fyffes claimed, did Fyffes themselves also not act unlawfully?

What as involved in this case was an allegation of major criminality on the part of one of the leading corporate figures in Irish business, Jim Flavin, the dynamic chief executive of DCC (see panel). His former friends and co-directors in Fyffes (see panel) alleged he had used "inside information" on the unfavorable trading performance on the part of Fyffes to time the sale of DCC share in the company, thereby defrauding the new shareholders (DCC had owned 10.5 per cent of the shares in Fyffes).

Had the case gone against Jim Flavin it is likely the DPP would have taken a case against him and had he been convicted of insider trading he would have been liable to a lengthy jail sentence (see panel on the Companies act 1990).

But what the case revealed was curious conduct generally, such as might merit further enquiry.

1. The salient facts

Fyffes financial year ran from 1 November to the following 31 October and in common with other public companies it announced its results at half-yearly intervals. It reported its preliminary results for the full financial year ended 31 October 1999 on 14 December 1999. This disclosed that the profits before tax and exceptional items had been ?82.9 million, an increase over the previous financial year by 5.1 per cent. That 14 December statement said Fyffes was confident 2000 would be "another year of further growth for Fyffes".

However things had begun to go wrong for Fyffes even by then the November figures were well below budget and well below the November performance of the previous year. But worse was to follow.

On 25 January 2000 a document was circulated to directors, including Jim Flavin, which included the actual trading performance for the first two months of the financial year (November and December 1999) and a hard forecast for January 2000 (the first quarter of the financial year) showing the company was losing ?2.6m in that first quarter. This corresponded with a profit in the first quarter of the previous year of ?11.1m. The internal company forecast for the first quarter had been a profit of just ?4.7m. So the position was the company was faring ?7.3m worse than forecast and ?13.7m worse than performance in the first quarter of the previous year.

The following comments were appended to this information: "December showed very little improvement in market prices or sentiment on the already disappointing performance in November) with a multiple price war effecting an already over supplied market (in bananas)".

Meanwhile the share price was going through the roof for reasons unrelated to actual performance.

In the autumn of 1999 Fyffes had embarked on an internet venture, called worldoffruit.com, (wof.com). It introduced an internet fruit exchange, a business-to-business, on-line trading system. That was the era of the dot.com mania and the venture evoked huge interest, driving the share price of Fyffes upwards. On 1 December 1999 the share price had been at ?1.60. It was at ?2.62 on 25 January, at ?3.20 on 3 February, ?3.69 on 8 February, ?3.90 on 14 February, peaking at ?3.98 on 18 February and falling back to ?3.30 by 16 March.

Then on 20 March Fyffes issued what is known as a "profit warning" advising the market the trading performance was very much down on projections and on performance on the previous year. The statement said the trading environment in the early part of the current financial year had been very difficult and, in particular, market conditions in the last two months of calendar year 1999 were significantly below expectations. It continued; "The usual recovery in the first month of calendar 2000 had been slower than anticipated …. As a result we expect that the performance for the first half of the year, on a like for like basis, will be below that achieved during the same period of last year. Present trading is slightly improved but, at this stage, it is too early to predict whether the shortfall can be recovered in the second half (of the financial year)".

This caused the share price to fall from ?3.30 to ?2.70 in a single day and to ?2.46 in the following day, a drop of 25 per cent in two days. By the end of April 2000 it had dropped to ?1.85.

But Jim Flavin had arranged for all the DCC shares in Fyffes (10.5 per cent of the total shareholding) to be sold in three tranches on 3 February (when the share price was ?3.20), 8 February (when the share price was ?3.69) and 14 February 2000 (when the share price was ?3.90), approximately 5 weeks before the profit warning.

The contention of Fyffes in the case was that these sales of shares was unlawful because Jim Flavin at the time was in possession of price sensitive information arising from his directorship in Fyffes and in particular that he was in possession of the information contained in the document of 25 January which had outlined Fyffes' poor trading performance in the first quarter of the financial year.

Some of the Fyffes shares sold by DCC were bought by London institutional investors and, apparently, they promoted a London Stock Exchange investigation starting on 7 April 2000, into what had happened and, in particular, into what appeared to be the curious sequence of events: DCC had a director on the board of Fyffes, DCC sold its massive shareholding in Fyffes, making a profit of over ?80m and a few weeks later the share price collapsed. (The London Stock Exchange was empowered to investigate this because Fyffes and, incidentally, DCC, were quoted on it.) Subsequently the Irish Stock Exchange instituted its own investigation and that continued into 2001 and towards the end of 2001 the Irish Stock Exchange reported the mater to the DPP. As Ms Laffoy noted in her judgment: "There the matter rests".

2. The core issue

A key issue in the case was whether Jim Flavin actually "dealt" in the shares or whether he was a mere conduit between the stockbrokers and the company that actually held the shares for DCC, Lotus Green. Ms Laffoy found Jim Flavin had dealt in the shares. She said on page 169 of her judgment: "I hold that the evidence supports a finding that… Mr Flavin both caused and procured the dealing which resulted in the share sales").

We are not going into that issue here (see Matt Cooper else in this issue of Village). Fyffes share price would have dropped appreciably at the time DCC sold its shares in early February had the market known of the information contained in the internal document on 25 January. This was the document that had stated the results for the first quarter would be €7.3m worse than forecast and €13.7m worse than performance in the first quarter of the previous year.

Perhaps surprisingly, Ms Laffoy concluded there would have been no appreciable drop in the share price then, even though she found that the drop in the share price on 20 and March was due entirely to the reported poor trading performance of Fyffes, as stated in the 20 March statement.

And the reasons she gave for finding there would have been no drop in the share price in early February, even though the results for the first quarter were turning out to be so dismal, was because reasonable investors would have taken into account other information known about Fyffes at that time.

That other information that was known generally in early February 2000 was as follows:

(i) The market already knew that trading in bananas was proving difficult, so news of poor trading in the first quarter would not have come as that much of a surprise.

(ii) Fyffes had stated it was reducing banana imports into Europe in 2000 and this would come to benefit the company only in the later part of the year.

(iii) Fyffes had announced in December it would be focusing on cost efficiencies.

(iv) Fyffes had indicated in that December statement that it was keeping its options open regarding a major acquisition and it had the cash flow assets to enable it to do that.

She added another consideration which was controversial. It was the following:

On 27 January Fyffes announced it had given share options on 50,000 ordinary shares in the company, to its company secretary, Philip Halpenny. Under the rules of the Stock Exchange this would not have been permissible had there been "price sensitive" information available internally in the company at that time – in other words information that would cause the price of the shares to fall or rise if such information were known generally.

On 28 January Fyffes announced that a non-executive director, John Ellis had sold 45,000 ordinary shares in the company. Again this signaled to the market there was no price sensitive information available.

The point Ms Laffoy was making was that a reasonable investor, knowing of the poor trading performance in the first quarter but knowing also of the other information mentioned above would infer from the announcements about the share options and the share sale of a director that management in Fyffes did not believe the poor trading performance in the first quarter was significant in terms of the outrun for the first half of the year and for the year as a whole.

But surely this begs the question whether it was right for the share option arrangement to have been entered into at the time and whether John Ellis should have been allowed to sell shares at that time?

Curiously, she thought this dealing in shares was a further reason for her to conclude that the 25 January information on the poor trading performance for the first quarter was not price sensitive.

3. The share price

collapse

She said what was known internally on 25 January 2000 was appreciably different from what was stated in the "profit warning" of 20 March. As reported above, the 20 March statement had stated the following:

(i) Market conditions in November and December 1999 had been significantly below expectations.

(ii) January had also been poor.

(iii) Performance for the first half of the year would be below performance of the previous year.

(iv) It was not certain if the shortfall could be recovered in the second half of the financial year.

This announcement caused the share price to collapse and the question arises if this disclosure caused such a market reaction, how is it believable there would not have been a market reaction – although of a less marked nature – had the information made known internally on 25 January been public knowledge?

Ms Laffoy argued that the 20 March statement was based not just on three months' trading, as the 25 January document had been, but on almost five months' trading and, for the first time, it was acknowledged (a) the performance levels of the first six months of the previous year would not be matched and (b) there was doubt that the performance levels for the year as a whole would match that of the previous year.

It is true the 20 March information was more dismal that that contained in the 25 January document. But the 25 January document made it clear performance of the first quarter was well behind performance in the first quarter of the previous year, so how could it not be inferred performance for the first six months would not match performance for the first six months of the previous year?

All the factors that she argued a reasonable investor would have taken into balance in late January (the possibility of a future major acquisition, concentration on cost cutting and on the core business, reducing supply to the European market etc) all applied on 20 March. So how come there was a very significant price fall on 20 March and there would have been no appreciable fall at all in late January?

And note: she excluded from consideration the dot.com factor in both instances.

This, the most critical part of her judgment, seems strained. Strangely, in this massive judgment, which throughout (almost) is cogently and brilliantly argued, the reasoning seems most suspect on the central issue of whether the information in the 25 January document was price sensitive.

4. Other factors

The performance of Fyffes through this whole affair seems curious also.

First, Fyffes made no suggestion that Jim Flavin had engaged in insider trading until over 20 months later, October 2001, when its solicitors, Arthur Cox, wrote to DCC and Jim Flavin. Proceedings were initiated on 28 January, a week before the end of the statutory limitation period in relation to the taking of such actions.

Then there was the conduct of Fyffes at the time of the DCC shares sale.

There was telephone contact between Jim Flavin and Neil McCann on 3 February 2000 before the first tranch of shares were sold. They arranged to meet at the Great Southern Hotel at Dublin airport that evening between 6 pm and 7 pm. David McCann went along with his father. When Jim Flavin arrived they congratulated him and they shared a bottle of champagne.

On the following day Neil McCann wrote to Jim Flavin saying: "Further to our meeting last evening it is encouraging to note this morning that the share price has stood up but I think, in all our interests, it could be helpful if the remainder of the shares are disposed of, so they will not be overhanging the market. It is quite an achievement to have disposed of such a volume and get such a good reaction. Hopefully it augers well for the balance".

No hint of concern about insider dealing here.

On 21 March 2000, the day after the March 2000 profit warning and the collapse of the share price, a retired stockbroker and shareholder in Fyffes wrote to Carl McCann. The retired stockbroker raised questions about the timing of the profit warning, enquiring why it had not been issued earlier. Carl McCann said in reply: "It has been our experience over many years that performance in the months of November and December has not proved to be a particularly accurate indicator of likely trading patterns for the remainder of the financial year and a poor performance in those months in the past has not in itself resulted in a shortfall for the first half... In particular we are satisfied than an earlier announcement would not have been merited based solely on the performance in November and December".

Ms Laffoy commented on this: "There is a glaring contradiction between the last sentence quoted above and the kernel of the Plaintiff's (Fyffes') case against the defendants. On the one hand, the plaintiff told a disgruntled shareholder just three months after the shares sales that the considered opinion of its executives was that the availability of trading and earnings information for the months of November and December 1999 did not trigger a duty to make disclosure under the Listing Rules, while, on the other hand, just short of two years after the share sales these proceedings, which stand or fall on the core premise that the very same information was price-sensitive, were initiated".

Then there was the extraordinary grant of share options to the company secretary and the share sale by a director in late January 2000. Ms Laffoy says in her judgment:

"As a general proposition, if on 25 January 2000 Mr Flavin was precluded from dealing in Fyffes' shares because he was in possession of the information contained in the (25 January document), in my view, the company... Would not have been free to grant the options because the exceptions (in the Companies Act 1990) would not have applied". Carl McCann had said in evidence that giving clearance to Mr Ellis was a "mistake".

She said elsewhere in the judgment that it was not in issue in the proceedings whether a profit warning should have been issued after the 25 January document had become available internally to the board of Fyffes. But surely it should be in issue somewhere. If Fyffes claim Jim Flavin acted on "price sensitive" information, arising from the 25 January document, then surely there was an obligation on the company to let everyone know the company was performing poorly at that stage. This was especially so as two of the three analysts who gave evidence in the case were recommending investors to buy Fyffes shares precisely at that time.

The question arises: were investors hoodwinked by Fyffes' silence in late January/early February about the profitability of Fyffes and the signals given to the market by the disclosures of the share option arrangement and the director's shares sales and the failure to disclose the trading position at that time?

Certainly, as Ms Laffoy implied, if Jim Flavin was guilty of insider dealing, then Fyffes were guilty of wrongdoing over the shares option and shares sales and the failure to tell the market what was going on. During this time, incidentally, Fyffes' senior management were engaged in what are known as "road shows", presentations to would-be investors in Ireland, London, Europe and the US (11 in all) and at none of these presentations was the true contemporary state of the company disclosed. p