Stimulated by the lasting effects of the global financial crisis, regulators around the world have discovered a new-found fever for prosecution when it comes to holding directors to account for the ills of their companies.
Taken together, this new body of case law suggests a noticeable shift in judicial thinking when it comes to directors of investment funds and the duties that they owe.
One of the more high-profile decisions from Australia is the Centro case (ASIC v Healey & Ors [2011]) – a perfect example of the current trend in the judicial tightening of the noose.
Centro Properties, an Australian-listed real estate fund, and darling of the market, misclassified certain multi-billion dollar borrowings – liabilities that they told the market were non-current when, in fact, they were due within six months and, if not refinanced, had the potential to sink the business.
When prosecuted by the Australian financial regulator, the directors argued that they could not have been expected to know that the liabilities in question were current liabilities (that is, due within 12 months), as: (i) there had been recent changes to the relevant accounting standard, (ii) the documentation relating to the borrowings was complex, and (iii) they had been given insufficient time to review the relevant board packs. They further argued that they could not be held to have breached their duties as the errors had also escaped the attention of both management and the external auditors, on whom they had relied.
The court decided that the directors had breached their duties and, in doing so, dismissed their arguments for a number of reasons, including that the accounting standards’ meaning of non-current liability was “straightforward” and the complexity of the documentation was irrelevant – the directors knew (or should have known) that the borrowings were maturing in the short term, and are expected to have made the necessary enquiries of management and the auditors in this regard.
Leaving aside the specific determinations in the Centro case, there are some important, broad outcomes that directors of funds can – and should – take away:
• Directors who rely blindly on management or external consultants do so at their
own peril;
• Having a minimum basic knowledge of finance and accounting is important to understanding modern investment businesses, especially those with global strategies and complex legal and tax structuring; and
• Having a deep understanding of your business will enable you to apply an enquiring mind to the affairs of the company.
While the courts have not prescribed a basic financial literacy standard for directors, it is now clear that a certain level of financial literacy and numeracy is an essential qualification to sit at the boardroom table.
As for the issue of having insufficient time to review board packs, the message is clear: make time.
As the former chief executive of General Electric, Jack Welch, famously said: “Change before you have to.” And so it is for directors sitting on investment fund boards across the globe and, particularly, in Europe.
The process of change being seen in other markets (primarily in the US and Australia) for directors’ duties is unlikely to suddenly stop.
New approaches to risk management and boardroom best practice are developing in earnest, which will ensure that directors can perform at their optimal level, and mitigate the types of risks highlighted in Centro and others. Directors in Europe will be expected to do likewise.
All of this will help to restore investor confidence in Europe, and position it strongly for the next wave of investment activity.
Matthew Wrigley is a counselor in the corporate and commercial practice in the Guernsey office of Appleby
©2014 funds europe
