All above Board? - The impact of the James Hardie decision on board approval procedures

The recent case of Australian Securities & Investments Commission v MacDonald (No 11) (James Hardie case) [1] provides some hard lessons for directors and senior executives of companies concerning their responsibilities in relation to public statements made by the company.

In what has been described as “a landmark decision on corporate governance”[2], Justice Gzell held former directors and senior executives of James Hardie Industries Limited (JHIL) accountable for allowing misleading public statements to be made about the funding of the Medical Research Compensation Foundation (Foundation).

The lengthy judgment sets out important principles that should prompt companies to review their procedures for preparing and approving public announcements about significant corporate events.

The James Hardie Group manufactured and sold asbestos products over an extended period to 1987. The Foundation was established in 2001 to deal with asbestos related claims as part of a broader restructure of the James Hardie Group.

The board of directors of JHIL met on 15 February 2001 to consider matters associated with the Foundation, including a draft public announcement (draft ASX announcement) to the Australian Stock Exchange (ASX).

The draft ASX announcement contained statements to the effect that the Foundation would commence operations with assets of $284 million, would have sufficient funds to meet all legitimate asbestos claims, was fully funded and provided certainty for people with legitimate asbestos claims.

With some variations, JHIL forwarded the announcement to ASX on 16 February 2001 and, on the same day, the CEO Peter Macdonald held a press conference at which he discussed matters included in the announcement.

A significant amount of the judgment deals with the factual question of what went on at the board meeting on 15 February 2001 and, specifically, whether the non-executive directors of JHIL actually approved the draft ASX announcement.

To quote Justice Gzell, “None of them agreed that they had approved the Draft ASX Announcement.” However, despite this, his Honour ultimately determined that the draft ASX announcement had been put before the board meeting and approved by the directors.

As to the substance of the ASX draft announcement, Justice Gzell noted that:

• The unequivocal and emphatic statements concerning the sufficiency of funding of the Foundation to meet all future asbestos claims were not consistent with expert actuarial advice provided to JHIL, which indicated the difficulties of predicting the level of, and costs associated with, future asbestos claims.
• While the cashflow model used to determine the funding needs of the Foundation was reviewed by financial experts, these reviews were limited in scope and based on key assumptions.
• The question of whether the announcement was misleading should be assessed from the perspective of the class of persons to which it was directed. This included financial market analysts, investors and sufferers of asbestos related diseases. While some of the members of this class had a sophisticated understanding of company announcements, others had little knowledge of listed companies’ affairs.
• The less sophisticated members of the class would have assumed, incorrectly, that they could be certain that adequate funding had been established to cover all future asbestos claims. The more sophisticated members of the class would have assumed that the statements were based on certain assumptions but would have been misled into thinking that a conservative approach had been adopted in assessing the Foundation’s funding needs.

The draft ASX announcement was therefore found to be misleading and deceptive and, on the basis of the finding that the directors had approved that announcement, Justice Gzell found that they had breached their duty to exercise care and diligence under section 180 of the Corporations Act. In this respect, it is important to note that the focus of their breaches of duty was the wording of the draft ASX announcement, in particular, “the emphatic nature of the Draft ASX Announcement” and “the unequivocal and unqualified statements as to certainty of funding”. While the directors were entitled to rely on senior management and experts in relation to the assessment of funding needs, “the task of approving the Draft ASX Announcement involved no more than an understanding of the English language used in the document.”

Executive director and CEO, Peter Macdonald, was also found to have breached his duty of care and diligence by failing to advise the non-executive directors that the statements in the draft ASX announcement concerning the funding of future asbestos claims were too emphatic, and by failing to advise them of the limited nature of expert reviews of the cashflow model used in the calculation of the Foundation’s funding needs.

The general counsel of JHIL was found to have breached his duty of care and diligence under section 180 of the Corporations Act by failing to advise the directors that the draft ASX announcement was expressed too emphatically and that, by releasing a public statement in misleading terms, they would put JHIL in jeopardy. As general counsel, he had a duty to protect JHIL from legal risk and should have warned the directors that the draft ASX announcement was misleading.

The chief financial officer of JHIL was found to have breached his duty under section 180 of the Corporations Act by failing to explain the limited nature of the expert reviews conducted on the cashflow model. In this respect, he failed to do anything to dispel an erroneous belief on the part of the directors that the reviews were more significant than they actually were.

The judgment in the James Hardie case signals an alert to the directors and senior executives to review the way in which they participate in the formulation and approval of corporate announcements. While each situation will need to be assessed on its own facts, the following general lessons can be identified from the judgment:

• Directors must carefully review the wording of public announcements relating to significant corporate events.
  
  If directors review a public announcement, they have direct and personal responsibility for the wording of the announcement and are not entitled to delegate this responsibility to other directors, management, advisers or consultants.
  
  Although there is still a role for subcommittees established as part of governance procedures to oversee corporate disclosures, companies should involve their full board in the approval of public announcements concerning significant corporate events.
• When reviewing the wording of an announcement, directors must be familiar with relevant background material and ensure that the wording of the announcement is consistent with that material.
  
  All directors, including non-executive directors, have a duty under section 180 of the Corporations Act to exercise care and diligence to ensure that the company does not make public announcements that are misleading or deceptive.
  
  While directors remain entitled to seek and rely on advice from internal and external experts, they have a duty to carefully review that advice. Further, if there is a corporate announcement on the subject matter of the expert advice, the directors must ensure that the announcement is consistent with that advice.
• Senior executives must apply their specialist expertise to the subject matter and wording of corporate announcements and ensure that their input is communicated to the directors.
  
  Senior executives who are involved in the making of corporate decisions that affect the whole or a substantial part of a company’s business are classifiable as “officers” and, as such, have a duty under section 180 of the Corporations Act to carry out their role with the appropriate degree of care and diligence. In this case, the general counsel and the chief financial officer were held to be officers who breached this duty by not providing adequate information and warnings to the directors in connection with the public announcements made.
  
  Accordingly, when participating in a process leading up to a public announcement, senior executives must apply their specialist expertise to the subject matter and wording of the announcement and ensure that their input is communicated to the directors. This may necessitate executives having an opportunity to report directly to the board, rather than indirectly through the CEO, in order to ensure that directors are both properly informed on relevant issues and made aware of the risks associated with misleading announcements.

Footnotes

1. [2009] NSWSC 287
2. ASIC media release, 23 April 2009