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Understanding the Exposures and Liabilities of Directors in a Turnaround Situation

Fiona Shand
Partner November 2004

Table of Contents
1 Introduction
2.1 2.2 2.3 2.4 2.5 3.1 3.2 3.3 3.4 3.5 3.! 3.$ 3.+ 3.. 3.10

2 3

2 The Board and its duties

Statutory duties 3 Duty to prevent insolvent trading by the company 5 ther statutory duties ! "ommon la# duties o#ed by directors$ %he &nited States regime 10

3 Who is the Board?


Director 12 '(ecutive director 12 Non)e(ecutive director 12 Shado# director 13 "onduct #hich may give rise to classi*ication as shado# director 13 Pro*essional advisers 14 "orporations as shado# directors 14 **icers, senior managers and employees) "orporations -ct 14 Di**ering roles and burdens o* chair, e(ecutive and non)e(ecutive directors 15 Directors potential personal liability in insolvency / 0ater 0heel 1!

4 What is the Boards role? 5 ASX Corporate 1"

5.1 5.2 5.3 5.4 5.5 5.! 5.$ 5.+ 5.. 5.10 5.11


o!ernance Council

-S1 corporate governance principles 1. Principle ne2 3ay solid *oundations *or management and oversight 20 Principle %#o2 Structure o* the 4oard to add value 21 Principle %hree2 Promote ethical and responsible decision)ma5ing 22 Principle 6our2 Sa*eguard integrity in *inancial reporting 23 Principle 6ive2 7a5e timely and balanced disclosure 24 Principle Si(2 8ights o* shareholders 24 Principle Seven2 8ecognise and manage ris5 25 Principle 'ight2 'ncourage enhanced per*ormance 2! Principle Nine2 8emunerate *airly and responsibly 2$ Principle %en2 8ecognise the legitimate interests o* sta5eholders 2+

# Board co$position and the turnaround scenario 2"

!.1 4oard composition 2.

7 C%&'( " continuous disclosure re)uire$ents and the turnaround scenario 31

$.1 $.2 "ontinuous disclosure 31 Due diligence de*ence to continuous disclosure 32

* Conclusion


- company should 35

9n order to assess a 4oard:s role in a turnaround scenario, one must understand the 4oard and its role. 6or the present purposes 9 #ould identi*y a company being in a turnaround phase #here it is *acing immediate challenges to its pro*itability and thus not meeting the e(pectations o* its shareholders. %he challenges to pro*itability can either be halted or accelerated by the strategies identi*ied and implemented to address the di**iculties *aced by the company. &ltimately these strategies are the responsibility o* the 4oard. Principles surrounding the use o* the corporate vehicle are #ell 5no#n. %he mechanism o* incorporation creates a legal personality or separate entity distinct *rom the *ounders, entrepreneurs, employees, o**icers, agents and shareholders involved in the particular enterprise. %he veil o* incorporation creates a protective shield bet#een the company and its members ;see generally Saloman v Saloman1<. -s a separate entity a corporation is responsible *or its o#n debts and liabilities. %he corporation cannot rely on its members to meet those commitments e(cept to the e(tent that, in a company limited by shares, any shareholder:s contribution remain outstanding. %hese basic principles appear to have been *orgotten in the hysteria created by recent corporate collapses. 9* a shareholder can gain the protection o* limitation o* liability, #hy are directors *acing unlimited personal liability through holding a 4oard position #ith the company= -s a result o* such collapses as the >&S!3 billion collapse o* 'nron, the >&S104 billion demise o* 0orld"om and closer to home ?9?, ne.%el, ?arris Scar*e and the challenges *aced more recently by @ames ?ardie, corporate regulators have revie#ed the regulatory *rame#or5 o* corporate governance #ithin the e(isting common la# *rame#or5. %he tension bet#een shareholders: e(pectations o* directors and the ability *or a director to meet those e(pectations #ill necessarily increase rather than decrease in the present corporate climate. 7ost commentators and governments claim that the corporate *ailures are themselves proo* that the e(isting legal *rame#or5 o* directors duties and obligations is inadeAuate and should be toughened. 8ecent amendments, case la# and legislative proposals see5 to impose greater burdens on corporate o**icers and as a result, director:s e(posure to personal liability is increasing. 9s this the right ans#er= %his paper #ill e(plore the composition o* the 4oard, its duties, roles and responsibilities touching on some e(amples #here directors have been held responsible *or breaches. 6inally, the recent changes under "3'8P . #ith respect to continuous disclosure reAuirements

B1+.$C -" 22

#ill be discussed #ith a vie# to providing a snapshot o* the realities presently *acing directors in -ustralia.

The Board and its duties

%he 4oard is the protective and managerial shield bet#een the company and its members ;shareholders<. %he 4oard is vested #ith po#ers by its constitution or articles o* association as #ell as statutory po#ers pursuant to the Corporations Act 2001 ;"th< and the general common la# po#ers #hich have arisen through Dudicial precedent.


Statutor! duties %he main statutory duties imposed upon directors are *ound in the Corporations Act ;2001<. 9t should be noted that #hile the duties imposed by statute largely re*lect the concept o* the *iduciary relationship developed by the common la#, the Corporations Act ;2001< modi*ies andEor con*irms general la# duties imposed on a director.
SECT 1"# Bac$ground to duties of directors% other officers and e&plo!ees 1"#;1< %his Part sets out some o* the most signi*icant duties o* directors, secretaries, other o**icers and employees o* corporations. ther duties are imposed by other provisions o* this 3a# and other la#s ;including the general la#<. ;2< Section . de*ines both FdirectorG and Fo**icerG. F **icerG includes, as #ell as directors and secretaries, some other people #ho manage the corporation or its property ;such as receivers and liAuidators<.

0hile the imposition o* a duty to act in good *aith and in the interests o* the company is intended to ensure that directors are loyal to the company, the imposition o* a duty o* care ensures that directors per*orm their *unctions #ith a reasonable degree o* care and diligence.
SECT 1'( Care and diligence ) ci*il obligation onl! 1'( Care and diligence - directors and other officers ;1< - director or other o**icer o* a corporation must e(ercise their po#ers and discharge their duties #ith the degree o* care and diligence that a reasonable person #ould e(ercise i* they2 ;a< #ere a director or o**icer o* a corporation in the corporation:s circumstancesH and ;b< occupied the o**ice held by, and had the same responsibilities #ithin the corporation as, the director or o**icer. Note: %his subsection is a civil penalty provision ;see section 131$'<.

Section 1+0;1< codi*ies the general la# duty that a director must discharge his duties #ith a degree o* care and diligence that a reasonable person #ould have e(ercised i* they #ere a director. %he "ourt #ill ta5e into account the circumstances o* the corporation at the time the director allegedly breached his duties. Section 1+0;1< reAuires a "ourt, in assessing the per*ormance o* a director, to have regard to the actual circumstances o* the corporation

and the o**ice occupied by the director or the o**icer. 0hen a "ourt is being as5ed to determine #hether a director is in breach o* section 1+0;1< the test in determining #hether the director has acted #ith a degree o* care and diligence is obDective, but the "ourt #ill still ta5e into account the duties o* the particular director #hose case is be*ore them.
SECT 1'1 +ood faith ) ci*il obligations 1'1 Good faith - directors and other officers ;1< - director or other o**icer o* a corporation must e(ercise their po#ers and discharge their duties2 ;a< in good *aith in the best interests o* the corporationH and ;b< *or a proper purpose. Note 1: %his subsection is a civil penalty provision ;see section 131$'<. Note 2: Section 1+$ deals #ith the situation o* directors o* #holly)o#ned subsidiaries. ;2< - person #ho is involved in a contravention o* subsection ;1< contravenes this subsection. Note 1: Section $. de*ines FinvolvedG. Note 2: %his subsection is a civil penalty provision ;see section 131$'<.

Section 1+1 o* the Corporations Act ;2001< reAuires directors and senior e(ecutives to act in good *aith in the best interests o* the corporation, and *or a proper purpose. 9t replaces *ormer section 232;2< o* the Corporations Law. Section 232;2< imposed a duty o* honesty rather than good *aith on directors by reAuiring that Fan o**icer o* a corporation shall at all times act honestly in the e(ercise o* their po#ers in the discharge in the duties o* their o**iceG. No#, pursuant to section 1+1;1<;a< a director must have e(ercised his po#ers, including discharging duties in good *aith in the best interests o* the company. Section 1+1;1<;b< also provides that a director must have e(ercised his po#ers *or a proper purpose. %o establish a breach o* section 1+1;1<;b< it must be sho#n that the substantial purpose o* the director:s action #as improper or collateral to his duties as a director. %he issue is not #hether business decisions #ere good or bad, it is #hether the director has acted in breach o* his *iduciary duties. 9n determining #hether or not there has been a breach o* section 1+1 the "ourt has to determine #hether, but *or an improper or collateral purpose, a director #ould have per*ormed the act ;or not per*ormed the act<. Section 1+2;1<;a< states that a director must not improperly use his position to gain an advantage *or himsel* or someone else or to the detriment o* the corporation.
SECT 1'2 Use of position ) ci*il obligations 1'2 Use of position - directors other officers and emplo!ees ;1< - director, secretary, other o**icer or employee o* a corporation must not improperly use their position to2 ;a< gain an advantage *or themselves or someone elseH or ;b< cause detriment to the corporation. Note: %his subsection is a civil penalty provision ;see section 131$'<.


- person #ho is involved in a contravention o* subsection ;1< contravenes this subsection. Note 1: Section $. de*ines Fin*ol*edG. Note 2: %his subsection is a civil penalty provision ;see section 131$'<.

Similarly a director is precluded *rom utilising in*ormation received as a director *or his o#n purposes or to the detriment o* the company. %his provision closely lin5s #ith the FtrusteeG relationship o* the director:s role. Prosecutions in this area have *eatured instances #here directors have shared commercial in*ormation gathered by a company:s o**icers and utilised that in*ormation *or their o#n or related parties commercial bene*it.
SECT 1', Use of infor&ation ) ci*il obligations 1', Use of information - directors other officers and emplo!ees ;1< - person #ho obtains in*ormation because they are, or have been, a director or other o**icer or employee o* a corporation must not improperly use the in*ormation to2 ;a< gain an advantage *or themselves or someone elseH or ;b< cause detriment to the corporation. Note 1: %his duty continues a*ter the person stops being an o**icer or employee o* the corporation. Note 2: %his subsection is a civil penalty provision ;see section 131$'<. ;2< - person #ho is involved in a contravention o* subsection ;1< contravenes this subsection. Note 1: Section $. de*ines Fin*ol*edG. Note 2: %his subsection is a civil penalty provision ;see section 131$'<.


Dut! to pre*ent insol*ent trading b! the co&pan! "orporate regulators have attempted to impose a higher level o* liability on directors in an e**ort to ensure companies do not trade #hile insolvent. %he Corporations Act imposes civil penalties and personal liability on directors should a company incur a debt and is ;or then becomes< insolvent #here there #ere reasonable grounds *or suspecting the company:s insolvency ;section 5++I o* the Corporations Act<. 9n Commonwealth "an# of A$stralia v %riedrich 2 a director ;7a(#ell 'ise< #as held personally liable *or >.!,$04,..+. %he "ourt held that the director #as deemed to be liable *or debts incurred by the company that he had *ailed to prevent. 'ise #as deemed to have breached the predecessor o* 5++I o* the Corporations Act.
SECT -''+ Director.s dut! to pre*ent insol*ent trading b! co&pan! -''+;1< %his section applies i*2 ;a< a person is a director o* a company at the time #hen the company incurs a debtH and ;b< the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debtH and ;c< at that time, there are reasonable grounds *or suspecting that the company is insolvent, or #ould so become insolvent, as the case may beH and

;1..1< 5 -"S8 115H ;1..1< . -"3" .4!

;d< that time is at or a*ter the commencement o* this Part. ;1-< 6or the purposes o* this section, i* a company ta5es action set out in column 2 o* the *ollo#ing table, it incurs a debt at the time set out in column 3. ;2< 4y *ailing to prevent the company *rom incurring the debt, the person contravenes this section i*2 ;a< the person is a#are at that time that there are such grounds *or so suspectingH or ;b< a reasonable person in a li5e position in a company in the companyJs circumstances #ould be so a#are. Note: %his subsection is a civil penalty provision ;see subsection 131$';1<<. ;3< - person commits an o**ence i*2 ;a< the person is a director o* the company #hen it incurs a debtH and ;b< the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debtH and ;c< the person suspected at the time #hen the company incurred the debt that the company #as insolvent or #ould become insolvent as a result o* incurring that debt or other debts ;as in paragraph ;1<;b<<H and ;d< the personJs *ailure to prevent the company incurring the debt #as dishonest. ;4< %he provisions o* Division 4 o* this Part are additional to, and do not derogate *rom, Part ..44 as it applies in relation to a contravention o* this section.


/ther statutor! duties -dditionally, each State, %erritory and the "ommon#ealth see5 to impose personal liability on company directors. -t last count, there #ere nearly 300 pieces o* legislation across 11 Durisdictions #hich did so. Some e(amples are2 ;a< ;b< ;c< 9ncome %a( -ssessment -ct 1.+!H ccupational ?ealth and Sa*ety -ct 2000 / section 2!H "ommon#ealth "riminal "ode 1..5 as amended by the "ommon#ealth "riminal "ode -mendment ;-pplication< -ct 2000 particularly in re*erence to 6inancial Services 8e*orm and trustee and superannuation services to the public. Protection o* the 'nvironment 1!.H perations -ct 1..$ ) section

;d< ;e< ;*< ;g< ;h< ;i< ;D< ;5< ;l< ;m<

'nvironmentally ?aKardous "hemicals -ct 1.+5 ) section 53H Pay)roll %a( -ct 1.$1 / section 31"H 0or5ers "ompensation -ct 1.+$ / section 145-H 7oc5 -uctions -ct 1.$3 / section 5H 0or5ers "ompensation -ct 1.+$ / section 4-H 'lectricity Supply -ct 1..5 / section 101H 3and Sales -ct 1.!4 / section 25H "ontaminated 3and 7anagement -ct 1..$ / section !3H "ontaminated 3and 7anagement -ct 1..$ / section !4H

;n< ;o< ;p<

-gricultural 9ndustry Services -ct 1..+ / section 50H 8oad %ransport ;Ieneral< -ct 1... / section 42H and "oal 7ines 8egulation -ct 1.+2 / section 1!2.

* more concern is that there are over 25 di**erent *ormulations #hich impose personal liability on directors. Senator 9an "ampbell in @uly 2002 #rote to "-7-" / "orporations and 7ar5ets -dvisory "ommittee / raising concerns about the duties ;including the di**ering ones< imposed on directors by State, 6ederal and "ommon#ealth legislation. 0hilst it is not the purpose o* this paper to propound a particular position on the appropriate test *or personal liability o* directors, certainly some uni*ormity, #hich #ill only come a*ter considerable revie# and discussion, #ould be appropriate. 20 Co&&on la1 duties o1ed b! directors Prior to the rise o* -S9":s po#ers the traditional mode o* regulation has been Dudicial monitoring to ensure compliance to duty)based rules. %he traditional approach o* the "ourts #as generally to as5 #hether the substantial purpose o* a director:s action #as improper andEor collateral to their duties as a director. %his obviously involves the application by the "ourts o* a subDective test o* the conduct and intention o* the person subDect to the *iduciary duty. %he "ourt #ould engage in a t#o)tier process2 ;a< ;b< as a matter o* la#, the range o* permissible purposes *or #hich a particular po#er could be e(ercisedH and as a matter o* *act, #hether or not the actual e(ercise o* po#er in the speci*ic case be*ore the "ourt #as permissible or impermissible.

&nder this common la# approach the "ourt appeared loathe to inter*ere #ith directors: decisions or actions provided they #ere #ithin the legitimate realm o* managerial po#ers. %he main policy considerations underpinning this common la# approach have been recognised to include2 ;a< ;b< the balance o* po#er bet#een directors and shareholdersH the dual nature o* the director:s position ;being both representative o* the shareholders and managers o* the business enterprise<H and the proper e(ercise o* directors: *iduciary duties, especially #here the long)term interests o* the company ;as a separate commercial entity< con*lict #ith the short)term interests o* some or all o* its shareholders.


0hile the common la# test appeared simple, it has been di**icult *or a "ourt to determine ho# much de*erence should be given to the Dudgment o* directors in relation to their management o* companies. 9n

particular, there has been a great deal o* uncertainty surrounding ho# the "ourts #ould apply the supposed F#ell settledG principles to the *acts o* a particular case. &A sentinel asleep at his post contri'$tes nothing to the enterprise he is charged to protect( .3 -s Polloc5 @ o* the Supreme "ourt o* Ne# @ersey in %rancis v United )erse! "an# 4 stated &directors ma! not sh$t their e!es to corporate miscond$ct and then claim that 'eca$se the! did not see the miscond$ct the! did not have a d$t! to loo#( . "onversely directors are not reAuired to 5no# all *acets o* a corporation:s business to a minute degree. 9n A*A Ltd v +aniels5 "hie* @ustice 8ogers ac5no#ledged that a 4oard including individual directors could not manage the day)to)day operations o* a large company and that *unctions must be delegated to the e(ecutives. &,he directors rel! on management to manage the corporation. ,he 'oard does not e-pect to 'e informed of the details of how the corporation is managed. ,he! wo$ld e-pect to 'e informed of an!thing $ntoward or an!thing appropriate for consideration '! the 'oard(. . @udicially it #as ac5no#ledged that there should be some Fmid pointG bet#een the Lall 5no#ing: and Lblindly ignorant: director. %he di**iculty emerges as to #hat the mid point might be in any particular circumstance. 0hen #ould it be appropriate *or directors to rely upon management or e(ternal advisers in order to delegate investigation and management o* the company on #hich to ma5e corporate decisions= 8ogers "@ then recited #hat #ould become his underlying principle applicable to the claim o* reliance. &A director is /$stified in tr$sting officers of the corporation to perform all d$ties that having regard to the e-igencies of '$siness the intelligent devol$tion of la'o$r and the articles of association ma! properl! 'e left to s$ch officers . . . a director is entitled to rel! witho$t verification on the /$dgment information and advice of the officers so entr$sted. A director is also entitled to rel! on management to go caref$ll! thro$gh relevant financial and other information of the corporation and draw to the 'oard0s attention an! matter re1$iring the 'oard0s consideration. ,he '$siness of the corporation co$ld not go on if directors co$ld not tr$st those who are p$t into a position of tr$st for the e-press p$rpose of attending to details of management 2American Law 3nstit$te &4rinciples of Corporate Governance Anal!sis and 5ecommendations( pp 167 8 16.9. 5eliance wo$ld onl! 'e $nreasona'le where a director was aware of circ$mstances of s$ch a character so plain so manifest and so simple of appreciation that no person with an! degree of pr$dence acting on his 'ehalf wo$ld have relied on the partic$lar /$dgment information and advice of the officers 25e Cit! :1$ita'le %ire 3ns$rance Co Ltd ;SU45A< =2>9(.$

3 4

*il#inson v +odd 42 N@ 'A 234 ;"h 1++!< 432- 2d +14 ;1.+1< 5 ;1..2< $ -"S8 $5. ! ;1..2< $ -"S8 $5. at +!$ $ 9bid !+!

%his entitlement to rely upon management ;and by implication e(ternal advisers<, coupled #ith the belie* that the responsibilities #ere carried out, appeared to alleviate directors o* the need to veri*y #hether the responsibilities #ere carried out and to #hat e(tent. ?o#ever directors still needed to e(amine #hether a matter could be delegated and they still had to act reasonably by the delegation. -t this stage the bar #as not set very high. n appeal in +aniels v Anderson+, Ne# South 0ales "ourt o* -ppeal, "lar5e and Sheller @@- in their maDority stated Fa matter o* particular signi*icance in these appeals is the e(tent to #hich directors are Dusti*ied in trusting and relying upon o**icers o* a companyG and a*ter Auoting the preceding paragraph *rom ?is ?onour "hie* @ustice 8ogers continued2 &3n o$r respectf$l opinion it ;5ogers C)0s statement< does not acc$ratel! state the e-tent of the d$t! of directors whether non-e-ec$tive or not in modern compan! law(.. %hus a more rigorous approach in respect o* directors:, #hether e(ecutive or non)e(ecutive, duties to monitor the corporate a**airs moved the bar higher *or directors. n appeal, #hilst the non) e(ecutive directors still avoided a *inding o* negligence, the chairman #ho #as also the chie* e(ecutive o**icer #as *ound guilty o* negligence. %he "ourt stated that by accepting their 4oard positions the directors had assumed the responsibility o* e(ercising a reasonable degree o* care and diligence in the per*ormance o* their o**ice. %he source o* the duty o* care at common la# rested upon the principles o* pro(imity. 0hilst the old la# invo5ed a subDective test, more #as reAuired by society than Fsupine indi**erenceG. 0hilst the subDective test #as dismissed in *avour o* a more obDective one, the "ourt did concede that a director:s duty #as dependent upon the siKe and business o* the company and the e(perience or s5ills that the director purported to have to Auali*y as a 4oard member. %he po#er to control the management o* a company, it:s property and a**airs is typically vested by the company:s constitution in the 4oard o* directors. Directors duties are to the company and the shareholders as a #hole, rather than any individual shareholder. 6iduciary relationships may arise because a party has been appointed to act, or assumes to act, *or the bene*it o* another #hose appointment carries po#ers that could be e(ercised to the detriment o* that other. 9n ?ospital 4rod$cts Limited v United States S$rgical Corp ;1.+4<10 @ustice 7ason stated2 &,he accepted fid$ciar! relationships are sometimes referred to as relationships of tr$st and confidence or confidential relations 2compare 4hillips v "oardman 2199 vi@ tr$stee and 'eneficiar! agent and principal solicitor and client emplo!ee and emplo!er director and compan! and partners. ,he critical feat$re of these relationships is that the fid$ciar! $nderta#es or agrees to act for or on 'ehalf of or in the interests of another person in the e-ercise of a power or
+ .

;1..5< 1! -"S8 !0$ 9bid 10 15! "38 41 at .!).$

discretion which will affect the interests of that other person in a legal or practical sense. ,he relationship 'etween the parties is therefore one which gives the fid$ciar! a special opport$nit! to e-ercise the power or discretion to the detriment of that other person who is accordingl! v$lnera'le to a'$se '! the fid$ciar! of his position. ,he e-pressions &for( &on 'ehalf of( and &in the interests of( signif! that fid$ciar! acts in a &representative( character in the e-ercise of his responsi'ilit! to adopt an e-pression $sed '! the Co$rt of Appeal. 3t is partl! 'eca$se the fid$ciar!0s e-ercise of the power or discretion can adversel! affect the interests of the person to whom the d$t! is owed and 'eca$se the latter is at the merc! of the former that the fid$ciar! comes $nder a d$t! to e-ercise his power or discretion in the interests of the person to whom it is owed.( -lthough a director is not a trustee the duties o* the o**ice are in some respects similar to those o* a trustee. %here are similar restraints such as the liability to account *or improper pro*its and pay eAuitable compensation *or improper loss o* company assets. %he standard o* loyalty is re*lected in a number o* positive obligations including2 ;a< ;b< ;c< ;d< %o act in good *aith in the best interests o* the companyH %o act *or proper corporate purposesH %o give adeAuate consideration to matters *or decisionH and %o 5eep discretions un*ettered.

-nd a number o* negative obligations2 ;e< ;*< 2%o avoid con*licts o* interestH and %o avoid improper use o* in*ormation in possession such as insider trading and *inancial bene*its to related parties.

The United States regi&e %he 4ush administration, in the *ace o* corporate governance and *raud upheavals in its mar5ets, signed into la# the Sar'anes-A-le! Act 2002 ;LS) -ct:< on 30 @uly 2002. %he -ct introduced s#eeping ne# la#s a**ecting corporate governance and disclosure, auditor independence and accounting re*orms. 7any o* the re*orms echo e(isting -ustralian reAuirements and standards, ho#ever, the &S regime in many instances *ar outstrips the -ustralian eAuivalent. %he S) ;a< -ct provisions directly relevant to directors liability are2 "' and "6 :s must personally certi*y the company:s *inancial reports to the S'". %his certi*ication includes their personal representations that they have revie#ed the accounts, that the accounts *airly represent the *inancial condition o* the company, and that the signing o**icer has designed, evaluated and made a positive assessment that he has received all material in*ormation through the internal control regime o* the company necessary to sign o** the accounts. -udit committees must only be comprised o* Lindependent: directors ;the &S de*inition o* Lindependence: is tightened<.


%he audit committee must appoint, consult and oversee the auditors, establish and adhere to procedures o* complaint and accounting matters and have the authority and *unds to retain independent advisers. ;c< ;d< 3oans to directors and o**icers are prohibited #ith certain limited e(ceptions. Directors, o**icers and shareholders holding more than 10M ;de*ined as Linsiders:< must report movement in shares, including options, #ithin 2 business days o* the transaction. 9n the event o* a company restating its *inancial accounts due to misconduct or a *ailure to comply #ith reporting reAuirements, the "' andEor "6 must *or*eit any bonuses or pro*its *rom securities transactions #ithin the t#elve month proceeding period. -ny person *ound guilty o* certain anti)*raud provisions can be disAuali*ied *rom public o**ice i* the conduct demonstrates Lun*itness: ) previously the standard #as Lsubstantial un*itness:. Disclosure o* periodic reports o* all Lmaterial: o**)balance sheet transactions and relationships #ith other entities that could have a material e**ect on the *inancial condition o* the company. -ny material changes in a company:s operations or *inancial condition must be disclosed on a Lrapid and current: basis. - public company is reAuired to disclose #hether its audit committee has any L*inancial e(pert: as a member.




;h< ;i<

9n 2003, the Sar'anes-A-le! Act sa# the S'" *reeKe payments to the *ormer "' and "6 o* Iem Star/%N Iuide 9nternational by *reeKing their severance payments amounting to >-&D!2 million under the cla# bac5 provisions #here *inancial accounts are subseAuently revised due to *raud. %he S'" *roKe the payments in circumstances #here the ne# "' restated past earnings. %his is the *irst occasion #hen Sarbanes) (ley provisions have been used to *reeKe e(ecutive payments be*ore the *iling o* charges. %he Ne# Oor5 Stoc5 '(change adopted during 2002 ne# mandatory ;blac5 letter< rules *or listed companies #hich are especially relevant to non)e(ecutive directors including2 ;a< ;b< ;c< %he reAuirement *or a maDority o* independent directorsH Separate audit, compensation and corporate governance committees ;each composed solely o* independent directors<H -doption o* corporate governance guidelines outlining director:s Auali*ications and responsibilities, entrenching director:s access to management, director:s compensation, orientation and continuing education guidelines, management succession and evaluation o* the 4oard:s per*ormance annually.


2ho is the Board3

Director %he 4oard is a composition o* individuals *alling into the categories o* chairman, e(ecutive directors, non)e(ecutive directors and independent directors. %hese terms are not mutually e(clusive and the "ourt has thro#n a #ider net indicating that the actions o* other individuals not holding *ormal positions can be deemed to be directors ) Fshado# directorsG. %he de*inition o* director is *ound #ithin section . o* the Corporations Act .
Section 9 Corporations Act 2001 (Cth) Director o* a company or other body means2 ;a< a person #ho2 ;i< is appointed to the position o* a directorH or ;ii< is appointed to the position o* an alternate director and is acting in that capacity regardless o* the name that is given to their positionH and ;b< unless the contrary intention appears, a person #ho is not validly appointed as a director i*2 ;i< they act in the position o* a directorH or ;ii< the directors o* the company or body are accustomed to act in accordance #ith the personJs instructions or #ishes. Subparagraph ;b<;ii< does not apply merely because the directors act on advice given by the person in the proper per*ormance o* *unctions attaching to the personJs pro*essional capacity, or the personJs business relationship #ith the directors or the company or body. Note2 Paragraph ;b<P"ontrary intentionP'(amples o* provisions *or #hich a person re*erred to in paragraph ;b< #ould not be included in the term QdirectorQ are2 Rsection 24." ;po#er to call meetings o* a companyJs members< Rsubsection 251-;3< ;signing minutes o* meetings< Rsection 2054 ;notice to -S9" o* change o* address<.


Executi*e director -n e(ecutive director is a director #ithin the meaning o* section . #ho is a *ull)time employee o* the corporation. %he main role o* an e(ecutive director is to carry out the day)to)day management o* the corporation:s business.


4on)executi*e director - non)e(ecutive director is a director #ithin the meaning o* section ., #ho is not an employee o* the corporation. 6or the purpose o* corporate governance reAuirements it is important to di**erentiate bet#een non)e(ecutive directors and independent directors. -n independent director must be a non)e(ecutive director, but must also Lbe *ree o* any business or other relationship that could materially inter*ere #ith, or be perceived to materially inter*ere #ith, the e(ercise o* their un*ettered and independent Dudgment: 11.


-S1 Principles o* Iood "orporate Iovernance and 4est Practice 8ecommendations, 7arch 2003, 1.. See also 4o( 2.1 o* the -S1 Principles *or a more comprehensive de*inition o* Lindependence:.


Shado1 director 9n general terms, a shado# director is a person in accordance #ith #hose directions or instructions the directors o* a company are accustomed to act. Section . o* the Corporations Act de*ines director broadly to include shado# directors. 7ore speci*ically, the de*inition e(tends to2 ;a< ;b< ;c< a person #ho is appointed to the position o* a director regardless o* the name that is given to their positionH 12 a person #ho is not validly appointed as a director but #ho acts in the position o* a directorH 13 and a person #ho is not validly appointed as a director but the directors o* the company are accustomed to act in accordance #ith the person:s instructions or #ishes.14


Conduct 1hich &a! gi*e rise to classification as shado1 director 9t is not necessary that a person, or a corporation, direct or instruct the 4oard on all aspects o* corporate management in order *or them to be deemed a shado# director. 9n A$stralian Sec$rities Commission v AS Nominees Ltd,15 6inn @ noted2 &,he reference in the section to a person in accordance with whose directions or instr$ctions the directors are &acc$stomed to act( does not in m! opinion re1$ire that there 'e directions or instr$ctions em'racing all matters involving the 'oard. 5ather it onl! re1$ires that as and when the directors are directed or instr$cted the! are acc$stomed to act as the section re1$ires.( 9n considering #hether a person is a shado# director, the "ourts #ill also consider #hether the person has the usual attributes and responsibilities o* a director. 9n +ep$t! Commissioner of ,a-ation v A$stin,1! 7adg#ic5 @ considered that directors2 ;a< ;b< ;c< ;d< are responsible to and have the con*idence o* shareholdersH manage the business o* the companyH sign cheAuesH and that the company seal is used only #ith their authority.

ther relevant *actors considered by 7adg#ic5 @ #ere2 ;e< ;*< ho# the persons are reasonably perceived by outsidersH and in the case o* small companies, the persons have acted as the company in relation to matters o* great importance to the company.

12 13

Corporations Act 2BB1 ;"th< S.;a<;ii<. Corporations Act 2BB1 ;"th< S.;b<;i<. 14 Corporations Act 2BB1 ;"th< S.;b<;ii< 15 1+ -"S8 45., 50.. 1! ;1..+< 2+ -"S8 5!5 ;7adg#ic5 @<H applied in +C, v Solomaon ;2003< 1.. -38 325.


6rofessional ad*isers %he Corporations Act de*inition o* director does not include persons #ho give advice in their pro*essional capacity or pursuant to their business relationship #ith the directors. ?o#ever, this carve)out does not mean that Ladvisers: #ill never be shado# directors under section .. %he "ourt #ill loo5 at the actual relationship bet#een the directors and the adviser. -s such, it is #orth considering precautionary steps advisers should underta5e so as not to be caught by the section . de*inition. "oburn 1$ has identi*ied these precautions as2 ;a< ;b< ;c< ;d< ;e< ;*< having #ritten terms o* appointmentH putting advice in #riting and 5eeping notes o* oral adviceH not signing company documents or authorisationsH ensuring they are paid *or their pro*essional servicesH not becoming a cheAue signatoryH and not negotiating #ith trade creditors.


Corporations as shado1 directors ?olding companies may also be a shado# director o* a subsidiary i* its directors e**ectively control the subsidiary:s 4oard. 9n Standard Chartered "an# of A$stralia Ltd v Antico 1+ Pioneer 9nternational 3td ;LPioneer:< #as held to be a shado# director o* Iiant 8esources, a corporation #hich it held 42M o* t#o #holly o#ned subsidiaries. %he *actors #hich caused the "ourt to *ind Pioneer as director included2 ;a< ;b< Pioneer had three nominee directors on Iiant 8esources eleven member 4oardH Pioneer had e**ective control o* Iiant 8esources through its 42M shareholding as the only other signi*icant shareholders held 10M and !M o* its sharesH Pioneer e(ercised management and *inancial control o* Iiant 8esourcesH and Pioneer reAuired Iiant 8esources to *ollo# *inancial reporting practices consistent #ith its o#n.

;c< ;d< ,'

/fficers% senior &anagers and e&plo!ees) Corporations Act "urrently, the Corporations Act contains potential anomalies in relation to the de*ined terms Fo**icerG and Fe(ecutive o**icerG. De*initions o* Fo**icerG are currently *ound in both section . and section +2- o* the -ct, #hich can lead to con*usion in relation to the application the statutory duties under Pt 2D.1 o* the -ct ;see ""? -ustralian "orporate Ne#s 9ssue +, $ 7ay 2003, pp +1)+2<. %he de*initions are not identical. 6or e(ample, the section +2de*inition includes an employee #hilst the section . de*inition does not. 0here a provision in the Corporations Act is intended to apply to


"oburn, Co'$rn0s 3nsolvent ,rading 22nd ed 2BBC9 1=7. "ited in Peter -rgardy, L0ho #ants to be deemed a director=: ;2004< 12;2< 3nsolvenc! Law )o$rnal 104. 1+ ;1005< 3+ NS038 2.0

its employees, the provision should clearly state that to be the intention. %he term Fe(ecutive o**icerG is currently de*ined in section . and is used to distinguish bet#een o**icers #ho ta5e part in the management o* the company ;e(ecutive o**icers< and ordinary employees. ,# Differing roles and burdens of chair% executi*e and non)executi*e directors David Snott ;the -S9" chairman< has described the decision o* @ustice -ustin o* the NS0 Supreme "ourt sitting at *irst instance in AS3C v 5ich1. as a landmar5 decision *or the delineation o* director:s duties in the modern corporate environment. -S9" brought proceedings against 4 o* the ! directors o* ne)%el / 3 #ere e(ecutive directors and the *ourth, @ohn Ireaves #as the non) e(ecutive chairman. 9n a preliminary application 7r Ireaves applied *or the proceedings against him, alleging a breach o* his statutory duty o* care, to be summarily dismissed. 7r Ireaves argued that his position #as virtually indistinguishable *rom the other 3 non)e(ecutive directors and that a company chairman had no greater responsibilities than other directors e(cept #ith respect to Fceremonial or procedural mattersG such as chairing directors or shareholders meetings. -S9":s argument #as not concerned #ith the duties o* a company at large but speci*ically #ith the duties o* a company chairman #ho on the evidence available #as2 ;a< ;b< ;c< ;d< - *oundation directorH "hairman o* the 4oardH "hairman o* the *inance and audit committeeH - Auali*ied chartered accountant #ho had substantial Fhands onG commercial and *inancial e(perience in listed public companiesH and "hairman #ho received >50,000 pEa plus superannuation *or his services.


-S9" argued that it #as these special personal Auali*ications and *acts, having regard to the particular circumstances o* ne.%el 3td, that set 7r Ireaves apart *rom the other non)e(ecutive directors. @ustice -ustin o* the NS0 Supreme "ourt #as satis*ied that the case to be argued by -S9" #as a tenable one on a preliminary basis. ?e revie#ed the legislative history o* the statutory duty o* care to ascertain the meaning o* the concept o* FresponsibilitiesG. ?is ?onour stated that a director:s responsibilities #ould include FTarrangements *lo#ing *rom the e(perience and s5ills that the director brought to his or her o**ice, also any arrangements #ithin the 4oard or bet#een the director and e(ecutive management a**ecting the #or5 that the director #ould be e(pected to doG and responsibilities acAuired by

B2003C NS0S" +5

virtue o* FT the e(pectations placed by those arrangements on the shoulders o* the individual directorG. 7uch o* @ustice -ustin:s reasoning #as based upon community e(pectations in light o* the recent corporate collapses rather than Dudicial precedent. 4ased upon 7r Ireaves: e(perience and the *actual scenario, the "ourt *ound that there #as a case to be ans#ered. 9t appears that @ustice -ustin accepted the proposition that the duty o* care and diligence under section 1+0 should be applied di**erently to directors, having regard not only to #hat responsibilities or roles the director holds #ithin a company but the s5ills and e(perience the director held #hen appointed. 9t is a li5ely conseAuence o* @ustice -ustin:s Dudgment that #hilst the #ording o* the statutory duties might be the same *or the chairman as *or another non)e(ecutive director, ho# those #ords are intepretated #ill vary dependent upon the respective responsibilities, s5ills and e(perience. %he subseAuent decision by 7r Ireaves not to contest the proceedings *urther and to plead guilty on terms agreed #ith -S9" #ill mean that @ustice -ustin:s Dudgment on this preliminary application #ill continue to de*ine the duties and obligations on a company chairman. 4ased upon the observations o* @ustice -ustin it #ould be *air to suggest that chairmen should revisit their per*ormance against the benchmar5s that this case has inevitably set. , 1( Directors potential personal liabilit! in insol*enc! 7 2ater 2heel SubDect to certain de*ences, section 5++I o* the Corporations Act provides, in essence, that a person #ill be in breach o* the section i*2 ;a< ;b< ;c< he or she is a director o* a company at a time at #hich it incurs a debtH and at that time the company is insolvent or it becomes insolvent by reason o* incurring the debtH and at that time there #ere reasonable grounds *or suspecting that the company #as insolvent or #ould become insolvent.

7r @ohn 'lliott and his co)directors o* the 0ater 0heel Iroup #ere *ound to have permitted the 0ater 0heel Iroup to trade #hile insolvent. %he illuminating aspects o* the case, *or the purposes o* this discussion, are the di**ering analyses o* the roles o* the directors #ithin this particular *actual matri(. 0ithout going into the *acts leading to the demise o* the 0ater 0heel company, the three relevant directors #ere 7r Plymin, the managing director, 7r ?arrison, the non)e(ecutive chairman and 7r @ohn 'lliott, a non)e(ecutive director. -s is the case in any action against directors *or insolvent trading -S9" had to prove that each time a debt #as incurred during the relevant period the speci*ic director should have considered #hether there #ere reasonable grounds *or suspecting the company:s insolvency. n the *acts presented the "ourt *ound 7r Plymin to be culpable and that his conduct #as Funreasonable and ine(cusableG and Frec5less

and grossly negligentG. 7r Plymin #as banned *rom managing a company *or 10 years ;reduced to $ years on appeal<, held liable to the compensate creditors o* the *ailed 0ater 0heel Iroup ;in total, an amount o* over >1.4 million< and #as reAuired to pay a pecuniary penalty o* >25,000. 7r ?arrison ;the non)e(ecutive chairman< co)operated *ully #ith -S9". 7r ?arrison pleaded guilty to the charges laid against him, no doubt a**ected by the *act that he intended to retire and not see5 any *urther positions as a company director. 7r ?arrison received a seven)year directorial ban ;suspended<, a >300,000 compensation order ho#ever no pecuniary penalty #as imposed upon him. 9n respect o* 7r @ohn 'lliott, the "ourt accepted his submission that the standard to be met by him #as that o* the reasonably competent and diligent non)e(ecutive director. 0hilst @ustice 7andie ac5no#ledged that the role o* a non)e(ecutive director #as di**erent to that o* the managing director or chairman, involving duties o* an intermittent nature to be per*ormed at periodic 4oard meetings, he speci*ically noted that the common la# and statute placed an Fincreasing onusG on non)e(ecutive directors. 0ith re*erence to 7r 'lliott, the "ourt *ound that there #ere numerous *acts and matters o* #hich 7r 'lliott 5ne# #hich, #hen ta5en together, constituted reasonable grounds *or suspecting insolvency. 7r 'lliott received a compensation order o* >1.4 million, *our years disAuali*ication and a pecuniary penalty o* >15,000. ?is appeal on all grounds #as unsuccess*ul. 9nterestingly, as bet#een the de*endants, at *irst instance the "ourt appeared to have the most sympathy *or 7r 'lliott, stating that he F#as signi*icantly less culpable than the managing director, 7r Plymin and less culpable than the chairman, 7r ?arrisonG.

2hat is the Board8s role3

%he -S1 "orporate Iovernance "ouncil ;the "ouncil< set out #hat it believed a 4oard #ould FusuallyG be responsible *or, including2 ;a< ;b< ;c< versight o* a company, accountability systemsH including its control and

-ppointing and removing the "hie* '(ecutive eAuivalent<H

**icer ;or

8ati*ying the appointment and, #here appropriate, the removal o* the "hie* 6inancial **icer ;or eAuivalent< and the "ompany SecretaryH 9nput into and *inal approval o* management:s development o* corporate strategy and per*ormance obDectivesH 8evie#ing and rati*ying systems o* ris5 management and internal compliance and control, codes o* conduct and legal complianceH

;d< ;e<


7onitoring senior management:s per*ormance and implementation o* strategy and ensuring appropriate resources are availableH -pproving and monitoring the progress o* maDor capital e(penditure, capital management, acAuisitions and divestituresH and -pproving and monitoring *inancial and other reporting. 20



9n the early period o* corporate e(perience the 4oard:s role #as one o* management. - managing 4oard:s duty #as dominated by ma5ing the internal decisions on a day to day basis o* the company and e**ectively managed the corporation:s business. SubseAuently, and #ith the globalisation o* commerce, a 4oard:s role became a monitoring one. %he more modern 4oard role o* monitoring the operations o* management o* the company ensured a separation bet#een the interests o* the shareholders and those o* the e(ecutives or managers o* the company. %hus the development o* public 4oard structure *rom insiders to e(ternal or independent directors. %he e**ect o* the legislative changes including the -S1 "orporate Iovernance "ouncil Principles o* Iood "orporate Iovernance and 4est Practice 8ecommendations, highlight the tension bet#een strategic monitoring and strategic management as 4oard *unctions. %he multiplicity o* 4oard *unctions has been e(tensively considered by 3ynne Dallas, #ho di**erentiates bet#een Lstrategic monitoring: and Lstrategic management:.21 Strategic monitoring encompasses the universally established management duties o* a 4oard including2 ;a< ;b< ;c< ;d< involvement in setting the corporations overall goals or missionsH overseeing and setting guidelines *or the development and implementation o* corporate strategyH pointing out strategic opportunities and issuing #arnings about environmental threatsH and evaluating senior e(ecutives #ith regard to their choices o* strategic initiatives and implementation o* strategic choices.

Strategic management also encompasses these duties, but goes one step *urther by including the controversial notion o* 4oard involvement in Lthe actual development and implementation o* corporate strategy:.22 %his distinction is use*ul in demonstrating that regardless o* #hether a 4oard underta5es strategic management, or restricts itsel* to strategic monitoring, it still has important managerial *unctions. 9n other #ords, a Lmonitoring model does not thrust a purely passive role onto the 4oard:.23 9* a turnaround company is one *acing immediate challenges to its pro*itability and thus not meeting the e(pectations o* its shareholders,

20 21

9bid page 1! Dallas, above n21, +0$. See also 3ynne Dallas, L%he 8elational 4oard2 %hree %heories o* "orporate 4oards o* Directors: ;1..!< 22 3owa )o$rnal of Corporation Law 1. 22 Dallas, above n21, +0$. 23 'isenberg, above n 21, 23..

the 4oard:s role is to identi*y and implement a strategy to ensure the success o* the turnaround. %he 4oard must assess2 ;a< ;b< ;c< ;d< the strategy including short and longer termEenvironmental conditionsH the current and prospective implementation or e(ecution o* the strategyH the culture o* the organisationH and the structure o* the organisation.

%hese *our core elements, #hich are e(pected to be measured against the -S1 "orporate Iovernance Iuidelines bearing in mind the continuous disclosure obligations, are critical to ensuring a success*ul turnaround #hich in turn #ill reduce the possibility o* personal liability *or the turnaround 4oard.

9S: Corporate +o*ernance Council

-t the second meeting o* the -S1 "orporate Iovernance "ouncil ;Fthe "ouncilG< on 1. September 2002 the "ouncil agreed to establish a #or5ing group to carry out separate strands o* #or5 on the various and comple( corporate governance issues under discussion. %he "ouncil agreed that issues to be dealt #ith by the #or5ing groups #ould *ocus on 4oard composition including FindependenceG o* directors. Some *actors *or consideration #ere2 ;a< ;b< ;c< ;d< ;e< "ompetency o* directorsH 'numeration *or related party transactionsH 9ntegrity o* reporting, including the e(istence o* audit committeesH 8is5 management and codes o* ethics *or senior managementH and Shareholder participation.

n 31 7arch 2003 the -S1 "orporate Iovernance "ouncil Principles o* Iood "orporate Iovernance and 4est Practice 8ecommendations #as released. -1 9S: corporate go*ernance principles %he "ouncil has identi*ied ten core principles #hich the "ouncil believes are *undamental to establishing a *rame#or5 to achieve best corporate governance principles. 9t is important to note that the "ouncil ac5no#ledges that the recommendations #ill not prevent corporate *ailures or mista5es. F-lthough the "ouncil:s recommendations are not mandatory and cannot, in themselves, prevent corporate *ailure or mista5es in corporate decision)ma5ing, they can provide a re*erence point *or enhanced structures to minimise problems and optimise per*ormance and accountability.G24

Page 3 -S1 "orporate Iovernance "ouncil Principles o* Iood "orporate Iovernance and 4est Practice 8ecommendations 7arch 2003

%he "ouncil e(pected the recommendations to be in practice by the *irst *inancial year a*ter 1 @anuary 2003. -s most -ustralian companies adopt @uly to @une reporting periods the *irst impact o* corporate governance reporting #as *ound #ithin the 2003)2004 corporate accounts. %he basic structure o* the "ouncil:s corporate governance principles is as *ollo#s2 ;*< 6undamental to any corporate governance structure is establishing the roles o* 7anagement and the 4oard ;Principle ne<. %he 4oard to include a balance o* s5ills, e(perience and independence appropriate to the nature and e(tent o* company operations ;Principle %#o<. %here is a basic need *or integrity among those persons #ho can in*luence a company:s strategy and *inancial per*ormance, together #ith responsible and ethical decision)ma5ing ;Principle %hree<. %he modern investment community e(pects in*ormation and reAuires processes that allo# the presentation o* a company:s *inancial and non)*inancial positions to sa*eguard, both internally and e(ternally, the integrity o* company reporting ;Principle 6our<. %he presentation o* in*ormation must be in a timely and balanced manner including all material matters ;Principle 6ive<. %he rights o* company o#ners, i.e. shareholders, need to be recognised and upheld ;Principle Si(<. 9t is recognised that all business decisions have an element o* uncertainty and carry a ris5. %hat ris5 can be managed through e**ective oversight and internal controls ;Principle Seven<. 6ormal mechanisms are reAuired to enhance 4oard and management e**ectiveness to 5eep pace #ith modern ris5s o* business and all aspects o* governance ;Principle 'ight<. 8e#ards are needed to attract s5illed individuals to achieve per*ormance e(pected by shareholders and these re#ards must be governed by clear and transparent guidelines ;Principle Nine<. %he impact o* company decisions and actions is increasingly diverse and good corporate governance recognises the legitimate interests o* all sta5eholders ;Principle %en<.





;5< ;l<




- summary o* the Principles is anne(ed as -ppendi( 9999. -2 6rinciple /ne; La! solid foundations for &anage&ent and o*ersight %he -S1 considers that the 4oard should recognise and publish the respective roles and responsibilities o* both 4oard and management to allo# a *rame#or5 designed to2

;a< ;b<

enable the 4oard to provide strategic guidance *or the company and e**ective oversight o* managementH clari*y the respective roles and responsibilities o* 4oard members and senior e(ecutives to ensure accountability by both the company and its shareholdersH and ensure a balance o* authorities that no single individual has un*ettered po#ers.


Comment %he -S1 considers that either the 4oard should adopt a *ormal statement o* matters reserved to it or provide a charter o* its responsibilities and *unctions. %hey list as an alternative a *ormal statement o* matters delegated to management ho#ever, best practice and one #ould assume transparency to shareholders, #ould suggest that a *ormal 4oard charter and a statement o* delegated authority to management #ould be a prudent course. %he "ouncil indicates that such material could be placed on the #ebsite. -t a minimum, such governance principles could be inserted, by a prudent 4oard, into any o**er or public documents. -, 6rinciple T1o; Structure of the Board to add *alue %he "ouncil considers that a company should have a 4oard o* an e**ective composition, siKe and commitment to adeAuately discharge its responsibilities and duties. %he "ouncil considers that an e**ective 4oard is one that *acilitates e**icient discharge o* its duties at la# and by its actions adds value to the company. %he 4oard should be structured so that it2 ;a< ;b< has a proper understanding o* and competence to deal #ith, the current and emerging issues o* the businessH and can e**ectively revie# and challenge the per*ormance o* management and e(ercise independent Dudgment.

Comment %he tension bet#een the corporate governance principles and reality is readily apparent #hen revie#ing Principle %#o. 0hilst the 4oard must have the understanding and competence to deal #ith the company:s current and emerging issues this may collide #ith the reAuirements o* independence to rob a company o* access to people #ho 5no# the company:s history and industry and thus be in a position to challenge the per*ormance o* management by e(ercising their Dudgment based upon their 5no#ledge o* corporate history. %he "ouncil has provided ne# guidelines *or independence #hich include a three year preclusion period *or '(ecutive **icers but does not include the prescriptive ten year director tenure nominated in the &S ?iggs report. 9t is noted that cross directorships and *amily ties FmayG be relevant #hen considering interests and relationships #hich may compromise independence. %he -S1 regime *alls *ar short o* the &S Sarbanes) (ley preclusions #hich are discussed at paragraph !.

%he "ouncil recognises the position at la# that the directors should bring independent Dudgment to bear in decision)ma5ing and help*ully suggests that the 4oard should agree in advance on a procedure *or the 4oard ;and presumably individual directors< to ta5e independent pro*essional advice and at the company:s e(pense. %his statement #ill come as a #elcome relie* to dissenting directors o* -ustralian 4oards #ho have to date *elt isolated *rom the 4oard and company resources #hen a maDor disagreement has arisen either #ithin the 4oard or bet#een 4oard and management. %he N-4E"atherine 0alter dispute is a prime e(ample o* a dissenting director:s choices. -n interesting concept o* Flead independent directorG is introduced in circumstances #here the chairman is not considered independent. 0ith the "ourts imposing a higher duty on a Non)'(ecutive chairman in AS3C v 5ich as discussed at paragraph 3.. one must also e(pect that a higher duty #ill be imposed upon any designated Flead independent directorG in the Dudicial decisions to come. %he recommendations identi*y the necessary FAualities, e(perience and reAuirementsG that should be considered #hen adopting 4oard positions. %hese re*lect the summary o* considerations listed at paragraph $ being the #riter:s vie#s on the matters #hich any prospective 4oard member should consider prior to accepting 4oard positions. nce again there is internal tension bet#een the e(pectations o* the "ouncil that a 4oard #ould be o* a su**icient siKe and composition to contain di**erent perspectives, s5ill and e(perience sets ho#ever be limited in siKe to encourage e**icient decision ma5ing. @ust ho# the nomination committee o* any o* the publicly listed companies deals #ith this tension is a matter o* conDecture. -0 6rinciple Three; 6ro&ote ethical and responsible decision) &a$ing %he "ouncil considers that a code o* conduct ;in conDunction #ith any code o* conduct recommended #ith Principle %en< should clari*y the standards o* ethical behaviour reAuired o* company directors and F5ey e(ecutivesG i.e. those o**icers and employees #ho could materially in*luence the integrity, strategy and operation o* the business and its *inancial per*ormance, and that the company should publish its vie#s on 4oard and employee trading in company securities. Comment %he suggestions *or the content o* a code o* conduct include a procedure to recognise con*licts o* interests limiting directors and e(ecutives *rom ta5ing advantage o* in*ormation *or personal gain and con*identiality. %hese suggestions largely mirror the reAuirements under Corporations Act at sections 1+0 / 1+3 ;inclusive< #hich reAuire directors to act in the company:s best interests rather than *or their personal bene*it. 0ithin the suggestions *or the content o* the code o* conduct it is interesting that item $, being encouragement o* the reporting o*

unla#*ul or unethical behaviour, ;F#histle blo#ersG< is not *urther developed #ithin the recommendations. -mpli*ication o* this concept #ould have been use*ul ho#ever could be vie#ed as di**icult to enunciate, particularly #here a de*inition o* ethical behaviour is reAuired. -6rinciple Four; Safeguard integrit! in financial reporting %he "ouncil considers that a 4oard must have a structure to independently veri*y and sa*eguard the integrity o* the company:s *inancial reporting #hich includes the ability to revie# and authorise accounts to ensure a truth*ul and *actual presentation o* the company:s *inancial position. %hat structure should include2 ;a< ;b< revie# and consideration o* the accounts by the audit committeeH and a process to ensure the independence and competence o* the company:s e(ternal auditors. 9t is noted that Fsuch a structure does not diminish the ultimate responsibility o* the 4oard to ensure the integrity o* the "ompany:s *inancial reportingG. 25

Comment 0hilst *e# #ould argue against the concept that the 4oard must ensure that a company has a structure to revie# its *inancial position, many companies and their 4oards have adopted the procedure that i* there are truly independent and competent e(ternal auditors then their auditor:s authorisation o* the company accounts and reports should comply #ith this principle. %he statement that this structure does not remove the 4oard:s ultimate responsibility to ensure proper accounting is a re*lection o* the e(tent and po#er o* delegation under the Corporations Act at section 1+. ho#ever the restatement o* the principle #ill disAuiet many directors. 8ecommendation 4.1 reAuiring the "' and "6 to *ormally advise the 4oard in #riting that the *inancial reports present a true and *air vie# adopts one o* the Sarbanes) (ley:s reAuirements on &S corporate o**icers. 9t is designed to result in more accurate and less Laspirational: reporting #hen lin5ed #ith the Corporation Amendment 25epa!ment of +irector0s "on$ses9 Act 2003. 8ecommendation 4.2 reAuires the establishment o* an audit committee comprising a minimum o* three non)e(ecutive directors ;a maDority being independent< #ith an independent chairperson #ho is not chairperson o* the 4oard. %he committee should have su**icient siKe, independence and technical e(pertise to discharge its mandate. %he "ouncil e(pects that companies #ill have an independent audit committee #ithin the ne(t three years. %he "ouncil has inserted a rider on the e(istence o* the audit committee that other non)audit committee members should not vie# its e(istence as lessening the responsibilities o* the 4oard as a #hole. %here are *urther echoes o* the Sarbanes) (ley in the reAuirement o* a *inancial e(pert #ithin the audit committee ;i.e. a Auali*ied accountant or other *inancial pro*essional< and that all members must be *inancially literate ;i.e. able to read and understand *inancial statements<. %he *inal reAuirement is that Fsome membersG must have an understanding o*

9bid page 2.

the industry in #hich the company operates. 9n vie# o* @ustice -ustin:s criticism o* 7r Ireaves as a chartered accountant and chairman o* the audit committee o* ne)%el, some companies may have signi*icant di**iculties in securing candidates to *ul*il the three reAuirements o* technically e(pertise *or their audit committees particularly given the reAuirement o* solely non)e(ecutive candidates and a maDority o* independent directors. -5 6rinciple Fi*e; <a$e ti&el! and balanced disclosure - company must have systems to promote timely and balanced disclosure o* all material in*ormation including *inancial, per*ormance, o#nership and corporate governance matters #ith investors having eAual and timely access to that in*ormation. "ompany announcements must be presented in a *actual, clear and balanced manner disclosing both negative and positive in*ormation. Comment %he "ouncil:s assumption that all investors have access to and understand the mechanisms o* corporate #ebsites belies the reality and identity o* most small retail investors and their level o* computer sophistication. 9* one analyses the shareholders o* the larger -ustralian companies #hich produce dividends a signi*icant portion o* shareholders ;in numbers rather than combined siKe o* shareholdings< are Fmums and dadsG investors, *or e(ample the I9 shareholders #ith small shareholdings held over *i*ty per cent ;50M< as opposed to institutional investors. -rguably the institutional investors #ith access to corporate brie*ings and internal analysts are in a much better position to access and consider the continuous *lo# o* in*ormation envisaged by the "ouncil. 6or the smaller shareholder the presentation o* Fbalanced= in*ormation reAuiring both positive and negative disclosures may #ell result in in*ormation e(pressed in other than in a Fclear and obDectiveG manner. %his might be particularly heightened in ta5e)over situations #here a 4oard is reAuired to ma5e a recommendation. ne also #onders #hether the pro*iles o* a company:s shareholders ;being small investors as opposed to institutional< #ill reAuire a t#o*old analysis by the 4oard o* any ta5e) over proposal. %his could lead to greater uncertainty and indeed di**ering vie#s ta5ing into account speci*ic shareholder groups and their interests, *or e(ample dividend streams versus capital gro#th. %he "ouncil #ishes the 4oard to establish policies and procedures to Fensure accountability at the senior management level *or complianceF ho#ever no mechanisms *or penalising *ailure at senior management are indicated. 9n the conte(t o* more onerous 4oard responsibilities senior management, particularly less ethical or scrupulous individuals, may ta5e advantage o* a 4oard:s increased responsibilities. -" 6rinciple Six; >ights of shareholders %he company, and thus the 4oard must respect the rights o* shareholders and empo#er shareholders by *acilitating e**ective communication #ith them, giving them ready access to balanced and understandable in*ormation and *acilitating participation by shareholders in general meetings.

Comment ne o* the suggestions adopted by the "ouncil to improve shareholder participation revolves around enhancing mar5et a#areness through electronic means. -s mentioned in the comments to Principle 6ive the increased emphasis on electronic communication ;through #ebsites< could disen*ranchise many smaller investors, being those parties most vulnerable or at ris5. -s an e(ample many o* the older community members have *elt signi*icantly disadvantaged by the ban5ing industry:s move to#ards electronic servicing o* customer:s needs. 8ecommendation !.2 being the attendance by the e(ternal auditor at the -I7 is a positive recommendation particularly i* the e(ternal auditor can ans#er shareholder Auestions on the conduct, preparation and content o* the auditor:s report. 9n these circumstances an auditor, i* subseAuently sued #ho hides behind corporate indemnities ;#ith the de*ence that they #ere not given access to the company:s accurate accounting records< #ould be at some ris5 in any subseAuent Dudgment. %his recommendation echoes section 250% o* the Corporations Act that states that if the auditor attends an -I7 the chairperson must allo# the shareholders a reasonable opportunity to as5 Auestions o* the auditor. %his -S1 recommendation, that the company reAuests that the auditor attend the -I7, goes *urther than section 250% o* the Corporations Act. -' 6rinciple Se*en; >ecognise and &anage ris$ - company must identi*y, access, monitor and manage a system o* ris5 oversight including management and internal controls #hich #ill enable it to in*orm investors o* material changes in the company:s ris5 pro*ile. Comment 0hilst it is envisaged under the recommendation that a separate ris5 management committee be established, the 4oard as a #hole ultimately has responsibility *or ris5 oversight and management and internal controls. %he policies suggested include identi*ying the roles and respective accountabilities o* the 4oard, audit committee, management and any internal audit *unction including components o* oversight, ris5 pro*ile, ris5 management, compliance and control and an assessment o* the e**ectiveness o* those controls. -rguably the preparation o* respective roles and responsibilities o* the 4oard andEor its separate committees as opposed to management is long overdue. ne o* the possible de*ences o* a 4oard to any shareholder derivative action could be the open communication to shareholders o* #hat the 4oard considered its role and *unctions as opposed to those o* senior management. 9* e**ectively delegated and supervised, not#ithstanding the occurrence o* a *ailure, the basis o* a de*ence o* a business Dudgment could be made out *or the 4oard and its directors. %he role o* the audit committee is stressed as one o* the e**ective tools *or monitoring internal *ailures particularly as is it is envisaged that the audit committee #ould *unction #ithout the presence o* management. %he role o* the audit committee in appointing and

dismissing any chie* internal audit e(ecutive is a good balance to the role o* the independent e(ternal auditor. 8ecommendation $.2 being the reAuirement o* the "' and "6 to state in #riting to the 4oard that best practice recommendations, being the integrity o* *inancial statements, have been *ounded on a sound system o* ris5 management may encourage management accountability. -# 6rinciple Eight; Encourage enhanced perfor&ance "ompanies should *airly and accurately revie# and encourage enhanced 4oard and management e**ectiveness on an individual and collective per*ormance assessment basis. Comment 9t is suggested that the per*ormance o* 4oard and 5ey e(ecutives be revie#ed against both measurable and Aualitative indicators. 9n recent -ustralian corporate e(perience a signi*icant number o* Auestionable option and bonus deals to "' s have been issued under previously agreed 5ey per*ormance indicators ;SP9:s<. %he di**iculty in assessing the Fvalue addG o* any esoteric *unction, such as the 4oard:s adding to strategic value, is ambiguous at best or at #orst impossible. 0hilst the recommendation suggests an induction program *or ne# directors enabling those individuals to gain a better understanding o* their o#n rights, responsibilities and duties, the role o* 4oard committees and the company:s *inancial, strategic, operational and ris5 management position, it is disappointing that the indicia to measure individual directors andEor 4oard:s Fvalue addG ;absent a chec5list *unction< is not e(plored in the recommendations to Principle 'ight. ?o#ever Principle 'ight does strongly recommend that a 4oard adopt a procedure *or directors to ta5e independent pro*essional advice at the company:s e(pense and have direct access to, as a minimum, the company secretary. 9t is disappointing that the "ouncil did not see *it to e(pand upon the dilemma o* directors Auestioning management and other directors to ensure accurate and independent value Dudgments against the *rame#or5 o* #ishing to ensure 4oard harmony. %he statement2 &+irectors sho$ld 'e entitled to and prepared to re1$est additional information where the! consider the information s$pplied '! management is ins$fficient to s$pport informed decision ma#ing(.2! does not address the dilemma *aced by many directors #ho *eel that their dissenting opinions have not been given adeAuate #eight and consideration. 9n light o* the *act that most 4oard minutes merely re*lect the decision by the 4oard rather than arguments, opinions and positions, this could be seen as a signi*icant lost opportunity *or the "ouncil.


9bid page 4+

- 1(

6rinciple 4ine; >e&unerate fairl! and responsibl! %he company and its 4oard is to ensure that the level and manner o* remuneration is su**icient to attract and maintain talented and motivated directors and employees including identi*ying the relationship bet#een per*ormance and remuneration in a manner that investors can understand. Comment %he "ouncil has adopted the e(pensing o* options #ithin its guidelines reAuiring the disclosure o* remuneration o* each director and the *ive highest paid o**icers o* the company. 9t is envisaged that disclosure #ould include items such as salary, *ees, non)cash bene*its, any bonuses andEor pro*it share accruing #ithin the *inancial year ;regardless o* #hen paid<, superannuation contributions, termination and retirement payments, value o* shares and options and any sign) on payments. Non)cash bene*its include loans ;other than those on commercial terms< and the amount and interest rate should be disclosed. 9* the 4oard is to e(ercise its discretion #ith respect to any bonus, stoc5 options or other incentive payments the basis *or the discretion should be e(plained. 9n an intervie# to the -ustralian 6inancial 8evie# on 31 7arch 2003 7s Saren ?amilton, chair#oman o* the "ouncil and -S1:s e(ecutive in charge o* en*orcing the listing rules, con*irmed that #hen a company entered into a strategic or operationally signi*icant contract it #ould merit disclosure under 3isting 8ule 3.1 being Fin*ormation that a reasonable person #ould e(pect to have a material e**ect on the price or value o* the entity:s securitiesG. -ccordingly this in*ormation *alls #ithin the reAuirement o* continuous disclosure. Previously the -S1 has not indicated that 5ey e(ecutive contracts #ould trigger disclosure under 3isting 8ule 3.1. &sing this analysis one #onders #hether 7r "hris "u**e:s contract #ith "olonial and subseAuently the liability acAuired by the "ommon#ealth 4an5 triggered and thus breached the continuous disclosure obligations under 3isting 8ule 3.1 not#ithstanding that the -S1 opinion #as not 5no#n until 31 7arch 2003. &nder -S1:s ne# reAuirements it #as open to -S1 to posthumously *ind both "olonial and the "ommon#ealth 4an5 in breach o* their continuous disclosure obligations. 8ecommendation ..2 suggests that the 4oard establish a separate remuneration committee consisting o* a minimum o* three members the maDority o* #hom are independent plus an independent chair. 9t is suggested that not only the content o* e(ecutive remuneration pac5ages but also the timing o* any bene*its be disclosed at the commencement o* any signi*icant e(ecutive:s employment or appointment including e(planation o* any balance bet#een *i(ed and incentive pay re*lecting short and long term per*ormance obDectives appropriate to the company and its goals. ne signi*icant di**iculty in this scenario is balancing entrepreneurial *ertilisation over a long period. -rguably the longer the contract ensuring strategic continuity, the greater the ris5 o* the 4oard attracting criticism. %his di**iculty might be balanced by annual disclosure o* accrued bene*its ;#hether paid or unpaid as at that date< and the inclusion o* tight termination clauses lin5ed to measurable SP9:s.

%he guidelines *or non)e(ecutive director remuneration are limited to *ees in the *orm o* cash, non)cash bene*its, superannuation contributions or eAuity. Speci*ically non)e(ecutive directors are e(cluded *rom schemes designed to remunerate e(ecutives, such as options or bonus payments and retirement bene*its other than statutory superannuation. 9n these circumstances, particularly in vie# o* greater 4oard responsibilities there is no# a good basis to argue that non)e(ecutive directors *ees in -ustralia are too lo# to adeAuately remunerate and attract talented non)e(ecutive directors. %he disparity bet#een community e(pectations o* 4oard per*ormance and director pay is becoming a Ftotal mismatchG according to David "ra#*ord a director o* 4?P 4illiton, 6oster:s, 3end 3ease, 0estpac and other companies. -rguably i* the community demands more o* directors then the remuneration *or non)e(ecutive directors must be reassessed i* the company is to attract and retain competent 4oard members. -lternatively the adage Lyou get #hat you pay *or: #ill ensure that shareholders get the directors they deserve. - 11 6rinciple Ten; >ecognise the legiti&ate interests of sta$eholders %he "ouncil suggests that companies recognise the legal and other obligations o* non)shareholder sta5eholders including employees, customers, clients and the community as a #hole. Comment -s is discussed at paragraph 2.3 there are a signi*icant number o* legal reAuirements a**ecting the #ay a company conducts its a**airs #here directors and o**icers are held personally liable *or corporate transgressions. %he "ouncil considers that the 4oard has a responsibility to set the tone and standards o* the company and to oversee adherence to the notions o* *airness, legitimacy and ethical behaviour. 9t is suggested that a code o* conduct relevant to the company:s compliance #ith its obligations to shareholders should be prepared and a guideline *or the content o* the code is indicated. %hose guidelines incorporate many o* the e(isting legislative reAuirements, *or e(ample occupational health and sa*ety, employment practices, security dealing obligations and the company:s monitoring and compliance #ith its code o* conduct. 0hat does not appear #ithin the guidelines *or the code o* conduct ;but rather appears as an e(planatory note< is a speci*ic mechanism #hereby employees can alert management and the 4oard in good *aith to potential misconduct. %his F#histle blo#erG reAuirement appears in the preamble rather than the guidelines themselves. -rguably until a #histle blo#er mentality is *irmly imbedded in corporate culture potential misconduct and actual breaches may not see the light o* day. %his principles)based approach is in star5 contrast to the rules)based ;or blac5 letter la#< approach adopted in the &S under Sar'anesA-le! Act 2002 or under the Ne# Oor5 Stoc5 '(change amendments agreed by the Securities '(change "ommission #here a mandatory rules approach has also been adopted. %he -S1 proposed guidelines are a signi*icant improvement on the 5nee Der5 reaction o* the &S Sar'anes-A-le! Act particularly by the

adoption o* an Li* not, #hy not: reAuirement o* reporting rather than a blac5 letter la# regime. ?o#ever, the "ouncil, in *ormulating the guidelines and primarily *ocusing on directorial rather than management activities, may have set the bar too high. %he result may be inertia at 4oard level or alternatively a chec5list mentality that esche#s the purpose o* engaging a diverse and competent 4oard.


Board co&position and the turnaround scenario

Board co&position %he composition o* a startup or promoter 4oard should be radically di**erent to a consolidation, turnaround or an e(pansionEgro#th 4oard o* a #ell established company. - good 4oard #ill understand the phase o* the corporation:s li*e at any particular moment in time and #ill tailor the composition o* the 4oard to e**ect an appropriate mi( o* talents among its 4oard members. %his tailoring o* 4oard composition ensures that the directors are appropriately aligned #ith the company:s present and *uture position. Ienerally the 4oard and individual directors revie# should, at a minimum, include the *ollo#ing aspects2 ;a< ;b< ;c< %he director:s o#n e(pertise, Auali*ications and e(perience and any Fholding outG o* the director:s s5ills to the company. %he director:s e(perience in the company:s mar5et and its business environment generally. %he e(perience, e(pertise and Auali*ications o* other 4oard members including their degree o* independence *rom the company. %he corporate culture o* 4oard involvement in the company:s a**airs ;Fthe mushroom mentalityG theory< including #hether the company is prepared to allo# directors un*ettered access to documents, management, internal and e(ternal advisers. %he e(istence and the composition o* the 4oard and any sub) committees. %he director:s o#n e(pectation and ability to invest time in the company:s a**airs including balancing same against other commitments and the remuneration o**ered. %he company:s strategic directions and in particular any changes in strategy a*ter acceptance o* a 4oard position. -ny de*inition o* the role o* the 4oard and sub)committees including SP9:s and any regime *or regular evaluations o* the 4oard and sub)committees per*ormance. %his includes #hether the 4oard or sub)committees have a policy *or their roles as opposed to a mere list o* activities.


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9t is advisable *or the 4oard and individual directors to consider at regular intervals their e(perience o*, and as a 4oard member o*, that company in its corporate climate. 52 Board co&position and the turnaround

@ust as a *unctional 4oard:s composition should di**er *rom its *ounding as opposed to consolidation phases, the 4oard composition must be assessed and changed ;i* necessary< in a turnaround scenario. 9* any 4oard member:s s5ills, e(pertise, industry 5no#ledge and level o* commitment do not align #ith the strategy identi*ied by the 4oard to ensure a success*ul turnaround then the turnaround #ill be unli5ely to succeed. -lternatively more pressure #ill *all upon those directors #ho do have the necessary s5ills, e(pertise, industry 5no#ledge and level o* commitment. 9n this climate the arguments in *avour o* a 4oard comprised o* independent directors, may be counterproductive to the success o* the turnaround. 9ndependent directors, purely by dint o* their independence, may have little or no actual or theoretical 5no#ledge o* the corporation, either in turnaround or healthy mode, or the industry in #hich the corporation e(ists. 9ndependent directors must commit a considerable amount o* time and e**ort, and ris5 personal e(posure to come to grips #ith an un*amiliar corporation and its environment. 6urther, independent directors, simply due to the reAuirements o* their independence, may be unable to assess the internal controls o* the corporation becoming increasingly reliant upon management *or in*ormation. 9ndependent directors are reliant upon management to provide them #ith adeAuate and accurate in*ormation regarding the corporation:s activities.2$ 0here management is engaging in corporate misconduct or *raudulent activities, it is unli5ely that they #ould give in*ormation to independent directors documenting this behaviour. 9n some circumstances the Auestioning o* e(ecutives by independent directors about corporate activities may elicit the e(istence o* a potential or e(isting problem. ?o#ever, the siKe and breadth o* corporate activity, particularly in large public corporations, means that the chance o* independent directors success*ully ascertaining a problem through the Auestioning process is, in the absence o* any other indicating *actors, negligible. - lac5 o* detailed 5no#ledge o* the corporation or the industry in #hich the corporation operates can also reduce the ability o* independent directors to monitor management per*ormance in general. 7onitoring management per*ormance is an important *unction o* the 4oard, given that the 4oard has the responsibility o* hiring and *iring the top)level e(ecutives. %he e**iciency o* an independent maDority 4oard as a monitoring mechanism is also reduced by the *act that the directors are reAuired to underta5e additional #or5 to attain a suitable understanding o* the corporation. "onseAuently, decision)ma5ing e**iciency is negatively a**ected because the decision)ma5ing process is li5ely to be delayed as outsiders digest the in*ormation reAuired to reach a decision. 2+

3aura 3in, F%he '**ectiveness o* utside Directors as a "orporate Iovernance 7echanism2 %heories and 'videnceG ;1..!< .0 Northwestern Universit! Law 5eview +.+. 2+ Stephen 4ainbridge, F- "ritiAue o* the NOS':s Director 9ndependence 3isting Standards: ;0or5ing Paper, 6ederalist Society *or 3a# and Public Policy Studies<, 4.

6urthermore, independent directors #ill need to be remunerated *or the additional time and e**ort put into researching and analysing the situation *or decision)ma5ing purposes. %his increases the e(pense o* the independent maDority 4oard as a monitoring mechanism, having an impact on its overall e**iciency. 6or these reason, arguably the -S1 independence reAuirements may not be an e**ective guide to the longevity o* the company. 9n a turnaround, a 4oard o* seasoned business people #ith company or industry speci*ic e(perience ;on the understanding that they have su**icient *inancial e(pertise< are better placed to develop and implement a ne# strategy su**iciently tailored to ensure a level o* success. 9n this regard -S1 principle 2 ) the str$ct$re of the 'oard to add val$e - could be argued to override the lac5 o* independence, given that should be directly responding to current an emerging issues *or the business. 9n these circumstances the -ustralian regime under the -S1 principle Fi* not #hy notG is vastly more responsive and *le(ible compared to its -merican counterpart under Sarbannes) (ley #here a prescriptive approach is demanded.


CLE>6 # continuous disclosure re?uire&ents and the turnaround scenario

ne *urther important recent aspect o* regulatory development should not be overloo5ed by the 4oard in a turnaround phase. 3isted companies are reAuired to immediately and publicly disclose in*ormation #hich #ould materially a**ect the price o* their shares. -s i* to rein*orce and to ensure compliance #ith -S1 Principles 5 and ! ) to ensure timely and balance disclosure eAually to all shareholders ) the 6ederal Iovernment introduced the "orporate 3a# 'conomic 8e*orm Program ;-udit 8e*orm and "orporate Disclosure -ct 2004 ;in *orce *rom 1 @uly 2004< ;F"3'8P . amendmentsG<. 9n a turnaround scenario it is critical *or the 4oard to balance the need *or discretion andEor secrecy in its activities #ith the burden o* compliance #ith the ne# continuous disclosure regime. 9 say Lburden: advisedly as -S9" under the "3'8P . amendments can see5 to impose penalties *or contravention not only upon the entity #hich *ailed to disclose but also its directors. %he 4oard and management #ill need to continually assess their actions and their results in light o* the duty to continually disclose to the mar5et.


Continuous disclosure %he "3'8P . amendments introduce a civil contravention o* the continuous disclosure rules #hich can lead to the imposition o* penalties on the entity and any individuals Lresponsible: *or the contravention. &nder the recent changes, persons FinvolvedG in a contravention o* the continuous disclosure rules #ill also be subDect to civil penalties ;sections !$4;2-< and !$5;2-<<. %hese changes are aimed at sheeting home responsibility to the natural persons ma5ing the decisions #hether or not to disclose certain in*ormation, i.e. directors and senior managers. 9n*ringement notices may be issued by -S9" *or continuous disclosure contraventions ;Pt ..4--<. %he in*ringement notice system is

intended to serve as an alternative to civil penalty proceedings under Pt ..44. 9n*ringement notices may be issued by -S9" #here it has Freasonable grounds to believeG that an entity has breached the continuous disclosure la#s. %he in*ringement notice system has come under criticism, principally on the basis that such an alternative en*orcement regime is inappropriate given the subDective nature o* the Dudgment as to the materiality o* in*ormation and the continuous disclosure carve outs. %he penalties generally under this section have been increased to >1 million *or the entity and a civil penalty o* up to >200,000 *or any individuals *ound to be involved in the breach. %he carve outs appear in 3isting 8ule 3.1;a< #here each o* the *ollo#ing tests are satis*ied2 ;a< ;b< ;c< a reasonable person #ould not e(pect the in*ormation to be disclosedH and the in*ormation is con*idential, and -S1 has not *ormed the vie# that the in*ormation has ceased to be con*identialH and one or more o* the *ollo#ing applies2 ;i< ;ii< ;iii< ;iv< ;v< it #ould be a breach o* the la# to disclose the in*ormationH the in*ormation concerns an incomplete proposal or negotiationH the in*ormation comprises matters o* supposition, or is insu**iciently de*inite to #arrant disclosureH the in*ormation is generated *or the management purposes o* the entityH and the in*ormation is a trade secret. internal

%he Corporations Act re*lects the ne# continuous disclosure reAuirements and in particular, at section !$4;2< #here it is stated that a *ailure to disclose relevant in*ormation to a mar5et operator, in circumstances #here the listing rules compel such disclosure, constitutes a contravention o* the -ct *rom #hich civil and criminal penalties #ill *lo#. Some o* the challenges *or companies in considering #hether in*ormation must be disclosed, are canvassed in -ppendi( 99 #here Iuidance Note + to 3isting 8ule 3.1 is reproduced. "2 Due diligence defence to continuous disclosure 9n much the same #ay that section 1+0 o* the Corporations Act provides a business Dudgment de*ence, an individual #ill not be held liable *or breach o* continuous disclosure rules i* they2 ;a< ;b< too5 all reasonable steps to ensure the listed entity complied #ith the continuous disclosure rulesH and a*ter ta5ing those reasonable steps, they believed on reasonable grounds that the listed entity #as in compliance #ith the continuous disclosure rule.

%he more problematic aspects o* personal liability *or individuals #hen *aced #ith a continuous disclosure charge arises *rom the concept o* FinvolvementG #ithin section !$4;2-< or section !$5;2-<. %he term FinvolvementG is de*ined #ithin section $. #here a person is involved in the contravention i*, and only i*, the person2 ;a< ;b< ;c< ;d< has aided, abetted, counselled or procured the contraventionH or has induced, #hether by threats or promises or other#ise, the contraventionH or has been in any #ay, by act or omission, directly or indirectly, 5no#ingly concerned in, or party to, the contraventionH or has conspired #ith others to a**ect the contravention.

-S9" #ill ta5e into account #hether an individual has been involved in the contravention o* the continuous disclosure provisions by assessing the 5no#ledge o* the person o* the Fessential elements o* the o**enceG including the issue o* materiality. %his test e(tends liability and adds to the pressure upon directors and corporate o**icers #hen they decide #hether in*ormation needs to be released to the mar5et and the timing o* that release. -n e(ample o* -S9" launching civil penalty proceedings, prior to the ne# continuous disclosure regime, is *ound in -S9":s prosecution in 6ebruary 2003 o* Southcorp 3imited. -S9" sought a declaration that Southcorp had contravened the then e(isting continuous disclosure provisions o* the Corporations Act. - Southcorp in*ormation o**icer had allegedly provided in*ormation to selected *inancial analysts concerning the impact o* the poor 2000 vintage on Southcorp:s 2003 *inancial results be*ore that in*ormation #as publically disclosed to the mar5et. 'ventually, the proceedings #ere resolved #ith Southcorp consenting to a declaration that it had breached the continuous disclosure regime. @ustice 3indgren o* the 6ederal "ourt made orders that Southcorp pay a pecuniary penalty o* >100,000 plus -S9":s costs o* the prosecution.2. %he Southcorp case #as the *irst to ever proceed be*ore a "ourt #here -S9" sought a civil penalty under the continuous disclosure regime. @ustice 3indgren noted2 Fspeculation and rumour deriving *rom selective disclosure is apt to cause a loss o* con*idence in the mar5et. Selective disclosure is inimical to belie* that a level playing *ield e(ists, as #ell as to its e(istence in *actG. 9t #as Southcorp:s behaviour a*ter the breach but be*ore sentencing that saved it *rom the ma(imum penalty then available o* >200,000. Southcorp designed and implemented a ne# continuous disclosure policy and through its senior management, then imposed and in*ormed all sta** o* the importance o* continuous disclosure. %his *act caused the imposition o* hal* the ma(imum penalty, despite the clear evidence o* a continuos disclosure breach by the company. 6or the turnaround 4oard balancing commercial realities in the *ace o* addressing rumours, potential ta5eovers and acAuisitions #ill be an

-ustralian Securities and 9nvestments "ommission v Southcorp 3imited ;No 2< B2003C 6"- 13!..

e(tremely challenging tas5. %his is particularly relevant #here directors or corporate o**icers may argue a positive case *or continuous disclosure o* certain in*ormation but are overruled *or e(ample by other 4oard members ;or in some circumstances by management< #ho *eel that disclosure is not #arranted and could indeed Deopardise the success o* the underta5ing. 9n those circumstances, the due diligence de*ence may not provide adeAuate protection to those persons, particularly i* they *eel they cannot disclose the in*ormation publicly i* this #ould lead to a breach o* their *iduciary duties to the company.


9t #ould be naive o* directors to e(pect a *ree or easy ride on any corporate 4oard in the present climate. 8ight or not, the corporate environment no# imposes severe and personal penalties *or *ailure, or perceived *ailures by 4oards, in discharge o* their duties. %he community appears to have come to e(pect to lay blame at someone:s door #hen a *ailure occurs / directors are the ne# targets. No more is this #arning more relevant than #hen a director sits on a 4oard o* a company in turnaround mode. So much can go #rong ) the industry, its environment, *oreign mar5ets, internal changes, corporate culture and sta** changes ) are all critical *actors in a turnaround situation #hich could lead to turnaround *ailure and corporate collapse. %he ris5 to directors are inherently heightened #ith the imposition o* personal liability through corporate breaches, insolvent trading and breach o* continuous disclosure rules. -S9" is cashed up, in relative terms, so it has the resources to prosecute directors. 'very 4oard and each director must continuously assess their particular roles and the 4oard:s role and actions. 0hilst the -S1 ac5no#ledges that even #ith the best corporate governance a company may *ail, directors should be a#are that shareholders may see5 to blame someone ) anyone ) *or their losses i* the turnaround is not a success.

966E4DI: I 7 T@E ESSE4TI9L C/>6/>9TE +/AE>494CE 6>I4CI6LES 1.1


9 co&pan! should
La! solid foundations for &anage&ent and o*ersight 8ecognise and publish the respective roles and responsibilities o* 4oard and management.

Structure the Board to add *alue ?ave a 4oard o* an e**ective composition, siKe and commitment to adeAuately discharge its responsibilities and duties.

6ro&ote ethical and responsible decision)&a$ing -ctively promote ethical and responsible decision)ma5ing.

Safeguard integrit! in financial reporting ?ave a structure to independently veri*y and sa*eguard the integrity o* the company:s *inancial reporting.

<a$e ti&el! and balanced disclosure Promote timely and balanced disclosure o* all material matters concerning the company.

>espect the rights of shareholders 8espect the rights o* shareholders and *acilitate the e**ective e(ercise o* those rights.


>ecognise and &anage ris$ 'stablish a sound system o* ris5 oversight and management and internal control.


Encourage enhanced perfor&ance 6airly revie# and actively encourage enhanced 4oard and management e**ectiveness.

>e&unerate fairl! and responsibl! 'nsure that the level and composition o* remuneration is su**icient and reasonable and that its relationship to corporate and individual per*ormance is de*ined.


>ecognise the legiti&ate interests of sta$eholders 8ecognise legal and other obligations to all legitimate sta5eholders.

966E4DI: II 7 +UID94CE 4/TE ' T/ LISTI4+ >ULE , 1

9rnold Bloch Leibler Understanding the Exposures and Liabilities of Directors in a Turnaround Situation 6age ,5