Directors’ duties of financial reporting have been made more stringent in the recent case of Australian Securities & Investments Commission v Healey  FCA717, a decision of Justice Middleton in the Federal Court of Australia. In particular, the case concerned the approval by the directors of the consolidated financial statements of Centro Properties Limited, Centro Property Trust and Centro Retail Trust for the financial year ending on 30 June 2007, at a Board meeting attended by the directors on 6 September 2007.
Composition of the Board
Only one of the non-executive directors had accounting qualifications. The remainder certainly had exposure to areas such as finances, investment banking, property and corporate governance through their exposure in directorships held before or because of legal qualifications that they had, but by no means did they have an in-depth understanding of the accounting standards applicable at the time.
Length of Board Papers
One of the expert witnesses called by the non-executive directors commented on the volume of material typically involved in producing the annual financial statements at Centro. He contended that it could involve “65 documents with 93 sets of complex financials at an average of 50 pages each which equates to over 3,000 pages in total“. Evidence was given that the Board papers typically arrived a week before a meeting but in the case of one of the non-executive directors would arrive approximately three to four days before the meeting.
Where did the directors slip up?
When the non-executive directors who were prosecuted in this case resolved at the Board meeting in September 2007 to approve the financial accounts for the year ending 30 June 2007, they failed to meet the requirements of the Corporations Act 2001 and the relevant accounting standards in three respects:
- they failed to notice the classification of some extremely large liabilities as non-current liabilities when they should have been categorised as current liabilities;
- they failed to add to the notes within the financial statements some changes that occurred beyond the balance date of 30 June 2007, namely that guarantees had been signed by the entities, which, if called upon, would have meant that short term liabilities would not have been able to have been met based on current assets;
- they relied upon a letter prepared by lawyers and accountants pursuant to section 295A of the Act which they would have realised was deficient in certain respects if they had turned their minds to the legislative provisions of the Act.
Naturally, the non-executive directors in question submitted in their defence that they had procedures in place whereby those at management level would see to it that the accounts were properly prepared and there was a process in place for recent changes to accounting standards to be taken into account when preparing the financial statements for the relevant financial year.
However, Justice Middleton said that it was not sufficient for directors to be able to say that they had applied due care and diligence to their duty of approving the financial statements by saying they had delegated the responsibility to management and advisers. The point was made that it is a specific requirement of the Act that the directors must approve the financial statements, indicating that directors must apply an inquiring mind to the process of having financial statements approved at Board level.
Evidence was given that the fact of the short-term nature of the large liabilities and the guarantees by the entities were made plain to the directors in papers at Board meetings since March 2007, so it was not new information. The Court noted that none of the directors had turned their mind to the issue of the need to report changes that materially affected Centro’s business beyond the balance date and that not all of the directors had considered the issue of current liabilities classifications and if they had, there was no clarity within their minds about how the classification was to be made.
The Court emphasised that the judgment does not require a level of perfection among directors nor does it require an in-depth knowledge of the accounting standards, but that if the directors had applied an inquiring mind to the categorisation of debts and the principles referred to in the financial statements at all then they would at least have made an inquiry in order to satisfy themselves that the financial statements were correct.
In the case of the declaration in relation to Centro’s financial statements from senior management prepared pursuant to section 295A of the Act, clearly the directors had simply relied on external advisers as to the accuracy of the letter. Justice Middleton made it clear that the law expects directors to satisfy themselves that such a letter is correct.
Principles to take forward
The judgment demonstrates that reliance cannot be placed lazily on external advisers or management to ensure correctness. The principle emphasised by Justice Middleton is best expressed in a quote that Justice Middleton cited by Justice Pollock in the case of Francis v United Jersey Bank  432A 2d 814:
A director is not an ornament, but an essential component of corporate governance.
A director must be an active member of the Board in the sense that he or she makes inquiries as to concepts that he or she does not understand or that may seem inconsistent with knowledge that he or she has as to status of the business’ finances. Directors must bring all of their knowledge of the workings of the business over a period of time to the fore when analysing financial statements.
It is our view that this decision will most likely be challenged further in the Court system, but directors should be aware that until such time as a new judgment is handed down, the law applies these stringent requirements on directors, which are applicable whether you are a director of a public company limited by guarantee or a listed company.
Further, statements in the case are applicable in the common law to the extent that they summarise the level of astuteness that directors must apply. So in our view, the principles that would be applicable in circumstances where trustees are managing accounts and also to members of committees of incorporated associations.