Background to the proceeding
The Australian Securities and Investments Commission (ASIC) made application under the Corporations Act 2001 (Cth) (Act) for declarations of contravention against the defendants (the directors) and for orders that each of the directors pay pecuniary penalties and be disqualified from managing corporations.
The allegations against the directors related to the approval of certain consolidated financial statements for the financial year ending 30 June 2007.
The 2007 annual reports for Centro Properties Group (CNP) and Centro Retail Group (CER) failed to disclose significant matters. The CNP report failed to disclose A$1.5 billion of short-term liabilities by classifying them as non-current liabilities, and failed to disclose guarantees of about US$1.75 billion that had been given after the balance date. The CER report failed to disclose A$500 million of short-term liabilities that had been classified as non-current.
Aside from the CFO, Romano Nenna, the remaining defendants contested the application. It was submitted by the directors that they had placed reliance on the qualified, competent and well-resourced financial management team and on the auditors, PricewaterhouseCoopers (PwC), and neither of those teams identified the above omissions. It was further submitted that failure to detect management's error and the auditor's error (if in fact there was an error) does not constitute a breach of any duties owed by the non-executive directors.
Justice Middleton's decision
Yesterday his Honour found that ASIC had proved that each of the directors participating in the resolutions approving the financial statements in question had contravened various sections of the Act by failing to take all reasonable steps required of them, and acting in performance of their duties as directors without exercising the degree of care and diligence which the law required of them. No distinction was drawn between executive or non-executive directors or whether or not a director was a member of an audit committee.
His Honour held that this was not a proceeding which concerned "a mere technical oversight". The information not disclosed was "a matter of significance to the assessment of the risks facing CNP and CER". The significant matters not disclosed in the CNP and CER reports "were known to the directors, or if not well known to them, were matters which should have been well known to them".
His Honour held that: "What is required is that such documents, before they are adopted by the directors be read, understood and focussed upon by each director with the knowledge each director has or should have by virtue of his or her position as a director. I do not consider this requirement overburdens a director, or as argued before me, would cause the boardrooms of Australia to empty overnight."
In commenting generally on the role of directors, his Honour noted the important role they play both for their companies and the wider community:
"A director is an essential component of corporate governance. Each director is placed at the apex of the structure of direction and management of a 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."
What does this decision mean for company directors?
Directors must carefully read and understand financial statements before they form the opinions which are to be expressed in the declaration required by section 295 (4) of the Act. A director must consider whether the financial statements are consistent with his or her own knowledge of the company's financial position. This "knowledge" arises from a number of responsibilities a director has in carrying out his or her role.
These include (as identified by his Honour):
- directors 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
- directors should keep themselves informed about the activities of the corporation
- whilst not required to have a detailed awareness of day-to-day activities, directors should monitor the corporate affairs and policies
- directors should maintain a familiarity with the financial status of the corporation by a regular review and understanding of financial statements
- directors, whilst not auditors, should have a "questioning mind".
His Honour also confirmed that directors are entitled to delegate the preparation of books and accounts and the carrying on of the day-to-day affairs of the company. However, each director is expected 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 on him or her. If necessary, directors must make further enquiries if matters revealed in financial statements call for such enquiries.
His Honour accepted that the non-executive directors reasonably expected that accounts produced by the accounting staff of the Centro entities would comply with the standards and that, if they did not for any reason comply, PwC or Centro's accounting staff would identify the error. However, in this proceeding ASIC did not criticise the process and procedures of the Centro entities. His Honour noted that "if they [the directors]had acted, as Senior Counsel for ASIC suggested, as the final filter, taking care to read and understand the financial statements, the errors may have been discovered earlier than they were".
Directors are required to focus on matters brought before them and to seriously consider such matters and take appropriate action. This task "demands critical and detailed attention, and not just 'going through the motions' or sole reliance on others, no matter how competent or trustworthy they may appear to be."
The directors argued that there was a lack of proper understanding by accountants generally of the significance in the change in accounting standards regarding the classification of liabilities as current or non-current. Indeed, there was evidence that all of the "big four" accounting firms, to varying degrees, misunderstood or failed to appreciate the significance of the changes.
This argument was essentially rejected by his Honour who found that there was no evidence that this was a cause or contributing factor to the directors' actions in the proceeding: "they did not say it was, and there is no evidence to connect any lack of clarity or uncertainty in the minds of third parties to the directors". He found that whilst directors are not required to be familiar with every accounting standard, they must be sufficiently aware and knowledgeable to understand what is being approved and adopted.
Watch this space!
The proceeding has been adjourned to allow the parties to attempt to reach agreement as to the declarations to be made against the directors. After handing down his judgment, Middleton J warned ASIC to consider very carefully what declarations it would now seek against the directors. He specifically noted that no suggestion had been made during the proceeding that the directors had acted dishonestly. Furthermore, they had relied on extensive advice and processes that were not called into question.
Counsel for the directors have indicated that they will make submissions that such declarations do not necessarily have to follow the finding of a contravention. ASIC has indicated it will make submissions that once a contravention has been found, it is mandatory for the Court to make declarations against the directors.
A hearing regarding the issue of declarations, relief from liability and penalties (if any) will commence on 1 August 2011. A further eAlert! will be published after that hearing.
There are also a number of related class actions underway against CNP and CER as well as PwC. The actions have been bought on behalf of security holders who acquired an interest in the Centro companies during the period in question and claim that CNP and CER breached their continuous disclosure obligations and engaged in misleading and deceptive conduct by failing to adequately disclose their true financial position.
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