The Judiciary Outlines The Responsibilities of Directors

The Centro Case attracted much interest as the expectations of directors and how they approach their responsibilities was explored.  Judge Middleton in his 2011 decision regarding the directors of Centro took the opportunity to clearly lay out how directors should approach their responsibilities. This article is a reminder of the onerous task of being a director.

Corporate governance remains central to the conduct of any publicly listed board in Australia and New Zealand.  The regulators and shareholders alike expect that boards have proper processes in place to ensure the effective execution of their responsibilities.  It is imperative that board members are aware of their responsibilities and that they conduct themselves in a manner which displays thorough professionalism.

Many boards seek the counsel of Egan Associates to guide them through some of their corporate governance challenges, be they related to board remuneration, board structure and effectiveness or indeed executive remuneration. The findings in the Centro Case are a good reference point for board members and Chairmen to reflect on as they undertake their important role.

The Centro Case attracted much interest as the expectations of directors and how they approach their responsibilities was explored.  Judge Middleton in his decision on the directors of Centro took the opportunity to clearly lay out how directors should approach their responsibilities.  The following is an extract from that decision.

▪       “The central question in the proceeding has been 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 and the proposed directors’ report, to determine that the information they contain is consistent with the director’s knowledge of the company’s affairs, and that they do not omit material matters known to them or material matters that should be known to them.

▪       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.

▪       This proceeding involves taking responsibility for documents effectively signed-off by, approved, or adopted by the directors. 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. Directors are generally well remunerated and hold positions of prestige, and the office of director will continue to attract competent, diligent and intelligent people.

▪       The case law indicates that 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 as a responsibility upon each director to approve or adopt.

▪        All directors must carefully read and understand financial statements before they form the opinions which are to be expressed in the declaration required by s 295(4). Such a reading and understanding would require the 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 a 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 board should be established which enjoys the varied wisdom, experience and expertise of persons drawn from different commercial backgrounds. Even so, a director, whatever his or her background, has a duty greater than that of simply representing a particular field of experience or expertise. 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.

▪       The words of Pollock J in the case of Francis v United Jersey Bank (1981) 432 A 2d 814, quoted with approval by Clarke and Sheller JJA in Daniels v Anderson (1995) 37 NSWLR 438, make it clear that more than a mere ‘going through the paces’ is required for directors. As Pollock J noted, a director is not an ornament, but an essential component of corporate governance.

▪       Nothing I decide in this case should indicate that directors are required to have infinite knowledge or ability. Directors are entitled to delegate to others the preparation of books and accounts and the carrying on of the day-to-day affairs of the company. 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. Such a responsibility arises in this proceeding in adopting and approving the financial statements. Because of their nature and importance, the directors must understand and focus upon the content of financial statements, and if necessary, make further enquiries if matters revealed in these financial statements call for such enquiries.

▪       No less is required by the objective duty of skill, competence and diligence in the understanding of the financial statements that are to be disclosed to the public as adopted and approved by the directors.

▪       No one suggests that a director should not personally read and consider the financial statements before that director approves or adopts such financial statements. A reading of the financial statements by the directors is not merely undertaken for the purposes of correcting typographical or grammatical errors or even immaterial errors of arithmetic. The reading of financial statements by a director is for a higher and more important purpose: to ensure, as far as possible and reasonable, that the information included therein is accurate. The scrutiny by the directors of the financial statements involves understanding their content. The director should then bring the information known or available to him or her in the normal discharge of the director’s responsibilities to the task of focussing upon the financial statements. These are the minimal steps a person in the position of any director would and should take before participating in the approval or adoption of the financial statements and their own directors’ reports.

▪       The omissions in the financial statements the subject of this proceeding were matters that could have been seen as apparent without difficulty upon a focussing by each director, and upon a careful and diligent consideration of the financial statements. As I have said, the directors were intelligent and experienced men in the corporate world. Despite the efforts of the legal representatives for the directors in contending otherwise, the basic concepts and financial literacy required by the directors to be in a position to properly question the apparent errors in the financial statements were not complicated.”

Concluding Observation

Justice Middleton’s observations in relation to the Centro case, which primarily reflect on financial matters, in our view are apposite to matters in relation to KMP remuneration and disclosures.  That is, it is our view that directors should fully appreciate the basis upon which annual incentive payments are made, their alignment with approved budgets and business plans and the quality and integrity of performance assessment.

In relation to equity based incentives we believe it is increasingly important that directors understand and approve the allocation of equity to KMPs, including the basis of allocation.  In this context directors need to be mindful of allocations which are based on accounting values, and allocations which are adjusted to reflect the difficulty and potential non-achievement of performance hurdles .

They also need to be assured and personally confirm the appropriateness of any benchmarking undertaken in relation to fixed remuneration of KMPs and ensure that there is alignment between adjustments made in this context and broader human resource strategies being adopted by the company.

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