Director’s Duties By Paul Anderson | August 2011 Area of Expertise | Business & Property
Summary
A recent Federal Court decision considers at length the duties of directors in relation to the preparation of financial statements of listed companies.
Who does this impact? The directors of a listed entity and their advisers.
What action should be taken?
Directors need to be familiar with the judgment and the detailed findings and be aware of the consequences of failure to comply. A recent Federal Court decision of Australian Securities and Investments Commission v Healey considered at length the duty of care of directors and, in particular, their obligations under the Corporations Act, 2001 (the ‘Act’) in relation to the preparation of financial accounts.
Background The Australian Securities & Investments Commission (‘ASIC’) applied under Section 1317E of the Act for declarations of contravention against the defendants in relation to Section 180 of the Act, and for orders that each of the defendants pay pecuniary penalties and be disqualified from managing corporations.
Facts The defendants were experienced directors of entities within the Cetro Property Group (‘CNP’) and the Centro Retail Group (‘CER’). CNP was a stapled entity consisting of Centro Property Trust, a managed investment scheme, and Centro Properties Limited. CER was a stapled entity consisting of Centro Retail Trust, a managed investment scheme, and Centro Retail Limited. The allegations related to the preparation of the consolidated financial statements for the year ending 30 June 2007. It was common ground that the accounts failed to disclose significant matters. In particular, in the case of CNP, the accounts failed to disclose:
• $1.5 billion in short term liabilities by classifying them as non-current liabilities, i.e. liabilities that were due for repayment later than 12 months; and
• Guarantees of short term liabilities of an associated company of about US$1.75 billion that had been given after the balance date.
In the case of CER, the annual report failed to disclose $500 million in short term liabilities by classifying them as non-concurrent liabilities.
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Defence The errors had not been detected by management and the external auditors. The directors argued that they had relied upon management and the external auditors and it was unreasonable to find them negligent in these circumstances.
Findings Mr Justice Middleton found that:
• The directors were intelligent and experienced and there was no suggestion of dishonesty; • The non-disclosure was not a technical oversight. The information was significant in the assessment of the risks facing CNP and CER, listed entities;
• The matters in question were well known to the directors or should have been well known. The essential question was whether directors of substantial publicly listed entities are required to apply their own minds to, and carry out, a careful review of the proposed financial statements. His Honour found that there was such an obligation. I do not consider this requirement overburdens a director, or as argued before me, would cause the boardrooms of Australia to empty overnight. Directors are generally well remunerated and hold positions of prestige and the office of director will continue to attract competent, diligent, and intelligent people. His Honour also made the following findings:
• All directors must carefully read and understand the financial statements before they form the opinions which are to be expressed in the declarations required by Section 295(4) of the Act.
• Directors should acquire at least a rudimentary understanding of the business and become familiar with the fundamentals of the business and its activities.
• A director should maintain familiarity with the financial status of the company. • It is not sufficient to ‘go through the paces’. A director is not an ornament but an essential component of corporate governance.
• Directors are entitled to delegate and may rely upon others. However, ‘what each director is expected to do is 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.’
• Directors cannot substitute reliance upon the advice of management for their own attention and examination of important matters.
• The standard required of directors is reasonable care and skill. Merely making a mistake does not demonstrate that due care and skill was lacking.
• It is not essential for ASIC to lead evidence by experts as to the appropriate conduct of directors and normal practice. In this case, it was the defendants who led expert evidence, most of which was adopted by the judge.
• Published materials on corporate governance were of assistance in determining the obligations imposed on directors. • While an audit committee has an important role to play, this is not to the exclusion of the role of a director to consider the financial accounts for himself or herself.
• The length and complexity of written information cannot be an excuse for failing to properly read and understand the financial statements.
• The omitted information was of importance to users of the accounts, particularly with regard to the ascertainment of the value of the underlying securities which were quoted and traded on the ASX. An error in the accounts of the entities could well result in litigation.
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Outcome The Judge found that each of the defendants had breached his obligations under the Act. The questions of relief from liability and penalty were adjourned to a later date.
Conclusion The case is a very detailed examination of the duties of directors in relation to the preparation of financial accounts of a listed company. It represents a significant and overdue victory for ASIC which has had not too many successes in recent times in major cases. Subject to the outcome of the further hearing on relief from liability and penalty, it must be a significant possibility that the directors will institute proceedings against at least the external auditors of the entities.
For more information, please contact: Paul Anderson Partner T: 02 8257 5742 paul.andersont@turkslegal.com.au
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Director’s Duties by Paul Anderson
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