The issue at the heart of the case the Australian Securities and Investment Commission brought against former directors and executives of the Centro Properties Group was deceptively simple. It was self-evidently so because Justice Middleton’s judgement, while vindicating ASIC’s decision to instigate the action, was 186 pages long.
Moreover, in delivering the judgement, in which he found the former non-executives and executives had breached the Corporations Act, Justice Middleton urged ASIC to carefully consider what it asks for when it returns to the court later this year to make submissions on penalties.
ASIC has asked the court to disqualify the directors and officers from managing corporations, as well as for fines to be imposed. The obvious interpretation of the judge’s directions is that he is inclined to treat the directors gently, saying there was no suggestion they were dishonest and describing them as “intelligent, experienced and conscientious people”.
The action brought by ASIC had nothing to do with assigning any responsibility for Centro’s collapse, but was rather about the degree of responsibility directors hold to ensure the information in their financial reports and market disclosures are accurate and in compliance with accounting standards.
ASIC has hailed the judgement a “landmark” decision in Australian corporate governance.
It quoted a passage from the judgement to put into context its broader significance for directors’ duties.
“A director is an essential component of corporate governance. Each director is placed at the apex of the structure of direction and management of the company. The higher the office that is held by a person, the greater the responsibility that falls upon him or her. The role of a director is significant as their actions may have a profound effect on the community and not just shareholders, employees and creditors,” Justice Middleton said.
So what did those directors and executives do that led to a landmark decision with implications for all directors of Australian companies? They misclassified some borrowings – actually quite a lot of borrowings – in their accounts.
The core of the case against the Centro directors is not that they knowingly misclassified $1.1 billion of short-term debt and failed to disclose a guarantee of an associated company’s borrowings, but that they should have known.
The Centro directors’ position was that they were entitled to rely on the advice of their specialist managers and of their auditors, PricewaterhouseCoopers. Justice Middleton said he accepted that the directors were assured by the auditors that the accounts complied with accounting standards and that, even after the error had been detected, it wasn’t brought to the board’s attention.
There are two other bits of relevant background.
The mistake was made during the period of transition to the Australian International Financial Reporting Standards, which had “materially different” criteria for classifications of liabilities.
Also, during that period, in the lead-up to the collapse of Lehman and the onset of the financial crisis, Centro was negotiating to roll over the short-term debt into longer-term borrowings – and had rejected some offers of funding that it believed were too expensive. Had it locked in that funding, the history of the group might have been quite different.
The problem with the judgement is that directors commonly rely on the technical expertise of their auditors or lawyers, as well as their management. Only one of the Centro directors, for instance, had an accounting qualification.
Should they have to second-guess their experts? Should they see their role as that of devil’s advocates, where every piece of information provided to them has to be regarded as suspect? Could a board function like that? Is it reasonable to impose those kinds of obligations on non-executives – people who, by definition, are part-time supervisors of management?
Justice Middleton provided a definition of a director’s responsibilities.
“A director should acquire at least a rudimentary understanding of the business of the corporation and become familiar with the fundamentals of the business in which the corporation is engaged; a director should keep informed about the activities of the corporation; whilst not required to have a detailed awareness of day-to-day activities, a director should monitor the corporate affairs and policies; a director should maintain familiarity with the financial status of the corporation by a regular review and understanding of financial statements; a director, whilst not an auditor, should still have a questioning mind.”
One doubts whether the Centro non-executives, or other non-executives, would take exception to that description of their responsibilities, nor with the judge’s view that nothing in his decision should indicate directors had infinite knowledge or ability.
“What each director is expected to do is to take a diligent and intelligent interest in the information available to him or her, to understand that information and apply an enquiring mind to the responsibilities placed upon him or her,” he said.
“Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their importance and nature, the directors must understand and focus upon the contents of financial statements and, if necessary, make further inquiries if matters revealed in these financial statements call for such enquiries.”
But what if the matters aren’t revealed? What if they are omitted, because an expert made a mistake?
And should the directors, who the judge said were usually given board papers comprising about 450 pages, have been focused on the detail of the financial statements presented to them by their management and the auditors or matters of economic substance?
Moreover, should they have had sufficient knowledge of accounting standards to be able to second-guess the experts they were paying to ensure the accounts conformed to the standards?
Self-evidently, Justice Middleton thought so, and ASIC agrees, saying the decision highlighted the danger of boards uncritically relying on management or the auditors and that each member of the board must bring and apply their own skills and knowledge when declaring financial statements are true and fair.
In the Centro case, the fact that even the practitioners had difficulty interpreting the standards appears to create an intimidatingly high threshold of expertise for non-accountant non-executives.
This is a judgement that will send yet another ripple of concern throughout the boardrooms of corporate Australia; boardrooms already feeling under siege because of the weight of their legislated responsibilities and liabilities.
