What does Australia's Experience have to teach us about the Changing Regulatory Landscape for UK Directors

Among these proposals, the UK government has proposed the implementation of most of the recommendations of the Kingman Report under which regulatory enforcement powers against directors of large companies will be both extended and strengthened.

To what extent will these changes lead to increased personal liability for directors? It may be that a case decided by the High Court in Australia ten years ago has some important lessons.  Before explaining why that is so, it is worth reminding ourselves what these proposals (which form only a small part of a more general and radical overhaul of UK corporate governance and audit regulation) contain. They include:

• The formation of a new Audit Reporting and Governance Authority (ARGA) which will replace the Financial Reporting Council. Whereas the FRC currently only has jurisdiction over directors with an accounting qualification, ARGA’s jurisdiction (as originally proposed under Kingman) was intended to be extend to all CEOs, CFOs, chairs and audit committee chairs regardless of their qualifications and now in the White Paper this has been further extended to all directors.
• ARGA’s powers will apply to all companies in the FTSE 350 and the Government is consulting on whether to extend the definition of a “public interest entity” — currently mostly limited to listed companies — to include all large private companies subject to specific thresholds and to certain universities, charities and housing associations.
• Directors of all companies within the new regime will become personally responsible for the accuracy of company financial statements through the sign-off of internal controls and risk management.
• There is also a proposal that directors in scope be subject to a new honesty and integrity standard which would allow the regulator to take action against a director who for example failed to act with honesty and integrity when deciding what information should be revealed to the auditor.
• Directors will face fines or temporary bans and the possibility of having to repay bonuses if they are found to have breached their duties to uphold corporate reporting and audit standards.

It is true that there are no proposals to change the legal standard as to skill and care expected of directors (as enshrined in section 174 of the Companies Act) under which they are required to demonstrate: “…  the care, skill and diligence that would be exercised by a reasonably diligent person with (a)the general knowledge, skill and experience that may reasonably be expected of a person

carrying out the functions carried out by the director in relation to the company, and (b)the general knowledge, skill and experience that the director has.” Nevertheless, the reality under which a new financial regulator assumes direct responsibility for the enforcement of standards specifically with regard to the accuracy of company financial statements is likely to have that effect and this is what the Australian High Court case of Centro may have to teach us.

The Centro Case

The case was brought by the Australian Securities and Investments Commission (ASIC) against seven directors (including the non-executive directors) of the various companies operating within the publicly listed Centro Properties Group for breaches of directors' duties in relation to their approval of the Group's 2007 financial statements. ASIC sought pecuniary penalties and disqualification orders against the directors. The relevant financial statements had failed to disclose some $1.5 billion of short-term liabilities by classifying them as non-current liabilities and failed to disclose guarantees of short-term liabilities of an associated company of about US$1.75 billion that had been given after the balance date.

There was no dispute as to the seriousness of the omissions. But nor was there any suggestion of dishonesty or misfeasance by any of the directors. In fact, the trial judge expressly found that they were: “intelligent, experienced and conscientious people.” The main thrust of the non-executive directors’ defence (and especially the defences of those who had no accounting background or qualifications) was that, in discharging their respective duties of skill and care, they were entitled to rely on an accounting team whose competence they had no reason to suspect as well as on the external auditors whose work was overseen by an experienced audit committee. They argued that ASIC was seeking to extend the responsibility of directors well beyond reasonable financial literacy and that the relevant errors were not detected either by anyone in the accounting team or by any of the professionally qualified executive directors. 

In a detailed 589 paragraph judgment, this is what the judge concluded:

...there is a core, irreducible requirement of directors to be involved in the management of the company and to take all reasonable steps to be in a position to guide and monitor. There is a responsibility to read, understand and focus upon the contents of those reports which the law imposes a responsibility upon each director to approve or adopt. All directors must carefully read and understand financial statements.... Such a reading and understanding would require a director to consider whether the financial statements were consistent with his or her own knowledge of the company's financial position. This accumulated knowledge arises from a number of responsibilities a director has in carrying out the role and function of director. These include the following:

• 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.... A director is not relieved of the duty to pay attention to the company's affairs which might reasonably be expected to attract inquiry, even outside the area of the director's expertise.... 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 hers.

Conclusion

The Centro case was brought by ASIC as regulator based on allegations of breach of directors’ duties, as it would be in the UK by AGRA under the new regulatory regime. The underlying standards of skill and care expected of directors in Australia and the UK are virtually identical and indeed in conducting an extensive review of the case law in this area the judge drew extensively on English law. So, it is not that the goal posts will be shifting with respect to the duties themselves. It is rather that directors can more readily be held to account by a regulator for such standards even in circumstances when there is no scope for a civil claim being brought against them.