The Centro Experience
On 27 June 2011 Justice Middleton of the Federal Court found that the Directors of entities referred to herein as 'Centro Properties Group' had breached their duty of care and diligence. Approaching two years since the decision, there continues to be impetus drawn from the findings, particularly in regard to the responsibilities of directors of Australian listed public companies. But what lessons are there for the directors and executives of 'other' Australian companies?
The directors approved for release to the public the relevant 30 June 2007 financial statements that misclassified certain borrowings as current liabilities, and which did not disclose certain significant guarantees of short-term liabilities given to an associated company after balance date. The outcome was a presentation contrary to the requirements of relevant accounting principles, and identification of the errors led to the preparation of a significantly restated financial report. A substantial fall in the value of Centro securities followed.
ASIC's allegation (upheld by the Federal Court) was that the Directors and Chief Financial Officer contravened the following sections of the Corporations Act in approving the financial statements: 180(1) - the duty to act with care and diligence; 344(1) - a director must take all reasonable steps to comply with the financial reporting obligations of the law, and 601FD(3) - the declaration in relation to a listed entity's financial statements by chief executive officer and chief financial officer.
At the time of Justice Middleton's judgement ASIC Chairman Mr Greg Medcraft commented that it was unequivocal in its message to boardrooms about corporate accountability:
'The central question in the proceeding was whether the directors were required to apply their own minds to, and carry out a careful review of, the proposed financial statements and the proposed directors report, to determine that the information they contained was consistent with the directors' knowledge of the company's affairs, and that they did not omit material matters known to them or material matters that should have been known to them.'
ASIC had sought harsher and more far-reaching penalties than the $30,000 fine imposed on the former CEO and the two year management disqualification for the former CFO. The six non-executive directors avoided any penalty other than court declarations and orders for payment of costs.
Justice Middleton stated:
'Whilst the Court has taken many factors into account, very much at the forefront of my consideration has been the issue of general deterrence. In my view, the orders go far enough to indicate the Court's disapproval of the actions of each of the defendants, and to satisfy the requirements of the principle of general deterrence. Any additional penalties are not necessary to facilitate the future adherence to the standard of corporate behaviour found to be required by the Court in this proceeding.'
Much has been written and presented, and resides in the public domain about the events and the outcome of the Centro case. A Google search identifies material generated by a range of authors including the Australian Institute of Company Directors, the Federal Government in relation to portfolio bodies operating under the Commonwealth Authorities and Companies Act 1997, various legal firms, and other accounting firms. We like the Group of 100 document 'The Centro Experience - a Wake Up Call for Directors', published in April 2012. For particular areas of focus it raises practical questions that assist directors in performing their appropriate due diligence, but also extends to a consideration of the support role of the CFO. It addresses the range of measures that may predominantly assist Directors of listed public companies. We have reflected on the document's guidance and tabulated our recommendations for the 'Chief Accountant' to support his or her directors in the discharge of their duties - and in this case, focusing on reporting entities that are not listed, but which are nevertheless responsible to users who are reliant on annual financial statements. We do not intend that our guidance covers small non-reporting entities, where users are limited and have adequate access to financial information - the principles nevertheless remain consistent.
We acknowledge that for the type of companies we are considering, directors will in many cases be heavily involved in the company's business, as executives. They will otherwise be non-executive, and fulfil an independent role. It is more likely that the Chief Accountant has a greater role to play in providing relevant financial information to a non-executive director (over an executive director), to fulfil the objective of drawing on their expertise. With regard to the Director's Obligation presented in the table below, we do not distinguish between executive and non-executive directors.
| Focus Area
|| Director's Obligation
|| The Chief Accountant's Support Role
||To maintain sufficient financial literacy to understand basic accounting conventions and diligence in reading the financial statements.
||Preferably at a meeting designed for the purpose, explain the impacts of technical and disclosure changes to the directors. Consider the role of pro-forma financial statements to support the explanation.
|Consider material business issues, non-routine transactions, and key judgements
||Acquire at least a rudimentary understanding of the business of the company and be familiar with business fundamentals.
Position board discussions to consider major transactions, material items, and key judgements, and question management about their treatment and disclosure in the financial report.
Establish that robust processes exist to support the reported outcomes, including access to experts, as appropriate.
|Be proactive and diligent in your duty to inform the Board of matters of this nature - even if a matter appears obvious or the Board is commercially astute.
Get professional/expert advice on material issues.
Prepare briefing papers and set aside time to ensure associated discussion with the Board; probe for questions.
|Annual report/ financial statements compilation process
||A director should maintain familiarity with the financial status of the company through regular review and understanding of financial statements, supported by:
> Comfort with the process of conversion of management accounts to the financial statements;
> Awareness of the timetable;
> Adequacy of time set aside;
> Documented audit trail of review discussion to reach conclusions.
|Maintain responsibility for the process, and plan so as to:
> Confirm consistency of financial statement close process, or describe changes to it;
> Agree the timetable with the Board, and deliver in line with it;
> Avoid risky timeframes - extend the timetable if required;
> Document discussions and agreed outcomes.
|Discussions with management about results and disclosure
||The Court in the Centro matter confirmed the importance of the annual accounts and the fact that the Corporations Act places specific responsibilities upon directors in relation to the accounts means that directors cannot delegate those responsibilities:
'Directors cannot substitute reliance upon the advice of management for their own attention and examination of an important matter that falls specifically within the Board's responsibilities as with the reporting obligations. The Act places upon the Board and each director the specific task of approving the financial statements.'
|Further impetus to establishing process steps per the above focus areas.
|Auditor's areas of focus
||Discuss with the auditor the key areas of business and financial risk, matters of audit focus, consistency of application of accounting policies, existence of any aggressive accounting treatments, and any disagreements with management.
||Consider preparing an internal report for consideration by the Board of the outcome of the audit process - transparency is key, particularly should a difference of opinion with the auditor exist, or a compromise has been reached.
|Enterprise risk including fraud
||Each member of the Board must bring and apply their own skills and knowledge, and take all reasonable steps to be in a position to guide and monitor.
||Coordinate the preparation of a business and financial risk matrix, for consideration by the Board at timely intervals - reference the financial statements against it.
|Consistency of corporate communications
||The directors should read, understand and focus upon the contents of reports which the law imposes a responsibility upon each director to approve and adopt.
By extension, other communications must not be inconsistent.
|'Checklist' the process to support the directors' approval of the financial statements and other communications to be released publicly by the company.
Maintain the standards expected by ASIC associated with the reporting of financial information.
||The Judge in the Centro matter stated:
'The complexity and volume of information cannot be an excuse for failing to properly read and understand the financial statements. It may be for less significant documents, but not for financial statements. The directors were in possession of the information. The information was provided to the directors by management for a reason.'
|Control the flow of information given to the Board to ensure that they keep the amount of paperwork to be read and digested within manageable levels. The complexity and volume of information presented to the Board cannot be an excuse for directors failing to properly read and understand important documents provided to them such as financial statements.
For further information contact one of our Audit & Assurance specialists.
This article is intended to provide commentary and general information. It should not be relied upon as authoritative advice. Formal advice may be warranted depending on particular circumstances.