In Brief
On 27 June 2011, Justice Middleton handed down his decision in ASIC’s civil penalty proceedings against the Directors of the Centro Group. Other than its obvious profile, the proceedings have excited interest due to the stark contrast between the apparent confidence of the non executive directors (evidenced by a “no case” submission) and the final result. So far, the prosecutions have been a total success for ASIC and the Directors will now have to wait until at least 1 August 2011 to find out if they will be relieved from liability.
The questions for the court related to the Directors’ approval of the June 2007 accounts of two Centro entities. It made decisive findings which highlighted the paramount importance of financial reporting and the vital role of directors in that process.
Background
Centro Properties Group and Centro Retail Group failed to disclose significant matters in their annual financial reports. The reports incorrectly classified in excess $1.5 billion of current liabilities as non-current liabilities. One report failed to disclose substantial contingent liabilities incurred post balance date. Centro discovered the misclassification early in 2008. The resulting trading halt led to investigations by both the ASX and ASIC and subsequently to these proceedings.
The Law
ASIC alleged that each of the seven Directors breached:
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s180(1) of the Corporations Act (duty to act with care and diligence)
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s601FD (1) of the Corporations Act which restates that general duty for officers of responsible entities
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s344 of the Corporations Act, which requires directors to take all reasonable steps to comply with, or secure compliance with, those sections of the Corporations Act concerning financial records and financial reporting
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s295(4) of the Corporations Act which requires directors to declare that: the company’s financial reports comply with the Corporations Act and, in particular, whether (a) they give a true and fair view of the company’s financial circumstances and comply with applicable accounting standards; and (b) they have received the mandatory declarations from the CEO and CFO required by s295A.
In Court
ASIC also took action against the CFO, who admitted contravention of ss 601FD(1) and 180(1) and did not actively participate in the proceedings.
The Directors each gave evidence which went (amongst other things) to:
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the structures and processes implemented by the Group to ensure the accuracy of the financial reports
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the volume and nature of the information in question
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difficulties with the application of the new accounting standards and transition from the old standards
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their qualifications and particular expertise
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their knowledge of the relevant accounting standards and statutory duties, and
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their knowledge of Centro’s debt position.
The Directors argued that, in all the circumstances, they were entitled to rely on the information and advice provided by both management and Centro’s auditors. ASIC, they said, was arguing for a standard of care which was unrealistic. They cautioned that this “counsel of perfection” would reduce the pool of talented directors prepared to take on the task.
The Directors pointed to the failure of the auditors and management to detect the errors to counter ASIC’s proposition that “Blind Freddy” could have detected them. Interestingly, ASIC did not lead expert evidence as what a reasonable director would have done in the circumstances.
Findings
The Court conceded that directors must, of necessity, delegate operational responsibility. They considered the claims in light of the paramount importance of financial reporting to shareholders and to the market, the statutory duties of boards with respect to financial reporting, and of the essential role of directors in guiding and monitoring the company.
Justice Middleton observed that the Directors were intelligent, experienced and well remunerated. He found that that they had breached s295(4) of the Corporations Act and therefore breached their general duty to act with the degree of care and diligence required of them.
In particular, His Honour concluded that directors (regardless of any particular expertise that they bring to the board) must understand and monitor the financial position of the company and apply an enquiring mind to the financial reports. As the Corporations Act makes each director responsible for the particular task of approving financial reports, each member of the Board was responsible for seriously considering the information available. They could not rely solely on others, no matter how trustworthy or qualified those “others” were.
Although it is not essential that directors have specialist accounting knowledge, they must have an “irreducible core” of knowledge of the company, its operations, regulatory requirements and financial position. They must also have sufficient financial literacy to permit them to apply an “enquiring mind” to the work done by management and advisers. In this case, the court concluded that basic knowledge of the relevant accounting standards (AASB 101 and 110) was an essential element in discharging their obligations as directors.
The court showed little sympathy for those of the Directors that pointed to the quantity and complexity of the information supplied to them. In response, His Honour reasoned that the Board was in a position to control the amount and the format of the information that it received. Therefore, the Directors could not rely volume or complexity as an answer to allegations of negligence.
Having said all that, His Honour found that the Directors were experienced, intelligent and diligent. He made it clear that there was no question of dishonesty and has not yet determined whether they should be relieved from liability.
Lessons for directors
The lessons for directors are relatively straightforward. They must:
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regularly refresh their knowledge of their obligations
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ensure that the company’s systems permit them to discharge their specific responsibilities in financial reporting (for example by ensuring that the information they receive is comprehensive, relevant and digestible)
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understand and monitor the company, its operations and financial position, and the market in which it operates
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have, or develop, sufficient financial literacy to be able to read, understand and critically evaluate the information and accounts supplied to them (noting that this will require a working knowledge of key accounting standards)
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apply their knowledge and actually read , understand and critically evaluate and analyse the information and accounts supplied to them.
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