The outcome of the corporate regulator’s pursuit of Centro Properties Group’s directors over alleged beaches of their duties will have far-reaching implications for corporate governance in Australia.
Not many Australians, not even directors and officers of large Australian corporations, would probably realise the active involvement of ASIC in civil litigation against directors is unique and distinguishes the Australian corporate law system from all others in the world.
This is particularly true when it comes to the enforcing directors’ basic duty of care, diligence, and duty to act in good faith and in the best interests of the company.
In all other modern corporate law systems it is primarily the duty of the company (practically meaning the shareholders), not the primary corporate regulator, to enforce these duties.
ASIC against the World
This is worth noting when it comes to assessing the importance of a win in the Centro case for ASIC.
Before 2009, ASIC has been remarkably successful in civil litigation with an impressive and almost impeccable track record of successfully instituting civil action against directors and officers.
However that year, as covered by our book Principles of Contemporary Corporate Governance, ASIC lost three high profile cases against the directors of One Tel Ltd, Jodee Rich and Mark Silbermann; former AWB Ltd managing director Andrew Linberg; and finally Fortescue Metals Group Ltd’s Chairman and CEO, Andrew Forrest.
(This case was later won on appeal at the Federal Court and Fortescue and Forrest (who announced recently he is stepping down as chief executive), is currently appealing in the High Court. The potential scalp of one of Australia’s richest men is obviously another driving reason for ASIC to pursue a successful prosecution.)
At the time though, ASIC’s litigation strategy was criticised quite severely and independently by all three judges in these three cases.
A hostile media then humiliated ASIC, questioning its ability to carry out complex litigation and accusing it of a flawed sense of judgment.
Therefore, there can be little doubt that ASIC would be very determined not to slip up on the Centro litigation.
Failure is not an option
In other jurisdictions where actions are instituted against directors for a breach of their basic duties, the litigation will be initiated by the company and in the name of the company – Greenbell Ltd v Smith and Others, not The Regulator v Smith and Others.
When the company is not successful in proving the breaches of directors’ duties, then there may be some collateral consequences for the litigating company.
It would probably have spent quite considerable amounts on legal fees, its brand name may suffer a bit and the share price of such a company may take a knock.
However, it will never be a case of “we must win otherwise the public will lose confidence in us”!
In contrast, a “must-win” is a high priority for ASIC to maintain “credibility” and not to suffer reputational damage as the primary Australian corporate regulator.
Test case
Aside from the reputational stakes, ASIC’s case against Centro’s seven directors and its CFO is also a test case on directors’ duty of care and diligence under section 180(1) of the Corporations Act.
ASIC alleges that the defendants failed to discharge their duties with due care and diligence in approving the financial reports for three property trusts - Centro Properties Ltd, Centro Property Trust and Centro Retail Trust - for the year ended 30 June 2007.
The allegation is that these financial reports contained material misstatements, specifically, that approximately A$1.5 billion of interest-bearing liabilities of each of the relevant entities were wrongly classified as non-current liabilities, rather than current liabilities.
ASIC alleges that the declaration, in writing, by the CEO and the CFO to the company directors that the financial reports complied with the accounting standards (AASB 101 - Presentation of Financial Statements) was lacking, but the board still signed off on the financial reports.
This declaration is required for listed entities in terms of section 295A of the Corporations Act.
ASIC has noted specifically that the Centro case is the first one where the section 295A will be considered in context of the board having signed off on the financial reports without a written declaration by the CEO and CFO required under section 295.
My prediction is that ASIC will use all its considerable legislative powers and regulatory resources to prove that even non-executive directors of Centro Properties Ltd should have known about the fact that a considerable amount of current liabilities were recorded in the financial records as non-current liabilities, instead of current liabilities.
ASIC will vigorously try to prove that non-executive directors of Centro Properties Ltd should not be shielded against liability because they relied on the advice of professional auditors, who prepared the financial reports or on the recommendation from the audit committee of the company that the financial reports could be approved.
Also, ASIC will forcefully argue that the non-executive directors have not adequately made “an independent assessment of the information or advice”.
This is a requirement to protect them against liability for relying on the incorrectly prepared financial reports and for relying on professional advice or advice provided by a board committee, in this case the audit committee.
It is highly likely that ASIC will go to considerable lengths to prove that there were no “reasonable grounds” for the non-executive to believe the information and advice from the auditors and management.
“Reasonable grounds” and murky waters
Interestingly enough, directors can rely on information and expert advice from a board committee, without “reasonable grounds” that the board committee competently fulfilled its role.
ASIC will argue that there were tell-tale signs that made it necessary for the non-executive directors to investigate further and insist on additional information or obtain further professional advice before they voted on the approval of the financial reports as board members.
In short, that they have acted negligently in not doing so and therefore breached their duty of care and diligence.
The water is quite murky when it comes to the exact circumstances under which directors can rely on the information and advice provided by others without having to do further investigations and obtain additional advice.
This is so because there are not many cases where the statutory provision (section 189 of the Corporations Act), protecting directors against liability when they relied on information or advice received from others, were considered in detail.
ASIC prowling
It means that directors who are swimming in these murky waters, with an active regulator such as ASIC prowling, should expect vicious and continuing attacks and even determination for a successful kill.
It is highly likely that as the case proceeds, the attention will shift to the question why the auditors have put A$1.5 billion in the wrong section of the financial reports – was that not an Accounting101 error?
As regulator ASIC can go on and on, almost ad infinitum, and appeal to the highest court until it achieves success.
In other jurisdictions the risks for directors are smaller. A company/shareholders considering civil action against its directors will do a careful cost analysis before they commence with litigation.
They will consider legal costs and the negative impact on its share price if they get involved in long, drawn-out and expensive litigation against its directors and officers.
Public interest
As far as ASIC is concerned, the fact of spending large amounts of taxpayers’ money on litigation would be a consideration, but the argument that it is acting in the best interests of the public in doing so will always be handy.
Without expressing any opinion on whether the Australian approach (active involvement of the primary corporate regulator) is better for enforcing directors’ duties than the approach (civil litigation undertaken by the company/shareholders) in other main modern corporate law systems, one thing is reasonably sure: the risk of Australian directors being sued for a breach of their basic duties seems much higher than for directors in other jurisdictions.
As primary corporate regulator, the fact that ASIC has both skin in the game and the considerable resources available to stave off reputational damage, makes it far more likely that it will try to secure a win, almost at all cost.
And that includes appealing to the High Court of Australia if it is defeated in lower courts.