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Above Board Winter 2011

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ABOVE BOARD (Winter 2011)

“ [A] director should acquire at least a rudimentary understanding of the business of the corporation and become familiar with the fundamentals of the business in which the corporation is engaged; a director should keep informed about the activities of the corporation; whilst not required to have a detailed awareness of day-to-day activities, a director should monitor the corporate affairs and policies; a director should maintain familiarity with the financial status of the corporation by a regular review and understanding of financial statements; a director, whilst not an auditor, should still have a questioning mind.” Middleton J in ASIC v Healey (the Centro decision, 27 June 2011).

While many directors would agree with Justice Middleton’s statement, it has sparked significant debate as to whether the Centro decision raises the threshold for directors too high.

In this edition of Above Board we summarise the key outcomes from the Centro case and look at other reforms relevant to directors in the listed, private and not-for-profit sectors.

Articles in this edition of Above Board include:

This quarter in our Governance practice section we discuss the role of the board in setting organisational culture.

We hope you find our latest issue of Above Board and its quick links to recent governance developments in Australia helpful and informative.

Best wishes

Kerryn Newton
Managing Director

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Centro case shines spotlight on financial expertise of directors

The recent decision of the Federal Court in the Centro Case has caught the attention of many directors both here in Australia and internationally.

Justice Middleton held that the six former and current directors had breached their duty of care and diligence by signing off the Centro entities’ financial accounts for the 2006/07 financial year that incorrectly classified over $2 billion of debt as non-current. The statements also failed to disclose a $2.8 billion debt guarantee.

The directors’ defence rested on their reliance on the advice from management and the company’s auditors. However, Justice Middleton found that directors should have had the financial literacy to detect the errors and that they had failed to independently assess the accuracy of the financial statements.

The court noted that there was no question that any director had been dishonest.

The case has raised a significant amount of commentary particularly regarding:

  • the extent to which directors’ can rely on and delegate to management or third party auditors
  • the degree of financial literacy required of non-executive directors, and
  • the respective roles of non-executive directors and management.

Penalties are yet to be handed down. ASIC is seeking disqualifications from managing corporations and fines.

The case highlights that directors need to consider financial reports in a detailed and critical way, and be able to independently assess compliance with key requirements.

A class civil action against the company and the auditors is yet to be determined.

A copy of the June 2011 decision can be accessed here.

 

Guidance on 30 June 2011 financial reports from ASIC

In the context of the need to ensure the accuracy of financial reports, ASIC has recently highlighted a number of focus areas for directors when considering 2011 financial reports.

ASIC’s guidance follows its review of 130 listed entities’ financial reports for the 12-month period ending on 31 December 2010.

ASIC’s review centred on:

  • segment reporting
  • consolidation of controlled entities
  • use of the going concern assumption
  • asset impairment
  • fair value of financial assets
  • financial instrument disclosures
  • disclosures of estimates and accounting policy judgements
  • accounting for business combinations
  • related party disclosures
  • operating and financial review, and
  • alternative profits.

Further detail can be accessed here.

 

NSW rolls back personal liability for directors

In its first parliamentary sitting day, the NSW government introduced legislation to remove provisions in 35 NSW laws which impose personal liability on directors for offences committed by the company. The bill was subsequently passed.

The effect of the Miscellaneous Acts Amendment (Director’s Liability) Act, which came into effect in May this year, has been to remove the relevant personal liability provisions in some instances. In other cases, the Act has amended provisions so that a director will not be liable unless it is proven that they were knowingly involved in, or permitted, a contravention of the legislation by the company.

It is estimated that over 700 laws nationally impose personal liability on directors and officers for conduct of their company.

In November 2009 the Ministerial Council for Corporations (MINCO) agreed to a set of principles to guide audits of all jurisdictional laws that impose personal liability on company directors. So far, only NSW and South Australia have taken legislative action.

 

Not-for-profits get own watchdog from July 2012

Following a recommendation from the Productivity Commission and subsequent wide consultation, the Federal Government has announced the establishment of a national not-for-profit (NFP) regulator. The Australian Charities and Not-for-profits Commission (ACNC) will be established by 1 July 2012 as an independent statutory agency.

The ACNC, rather than the ATO, will assess whether an entity is charitable, a Public Benevolent Institution or in another NFP category for Commonwealth purposes. The ATO will retain responsibility for administering tax concessions and will provide corporate support to the ACNC.

The Commission’s functions will include:

  • provision of a ‘one stop shop’ for NFPs and reduction of reporting and regulatory compliance by
  • implementing a 'report-once use-often' general reporting framework
  • provision of education and support functions
  • implementon of a public information portal by 1 July 2013, and
  • enhanced oversight of the sector including the use of not-for-profit tax concessions.

The ACNC will also be responsible for guiding the introduction of a new definition for the term charity to be introduced for all Commonwealth laws from 1 July 2013.

For constitutional reasons, it is anticipated that the ACNC will initially only regulate Corporations Act companies and trustees until further negotiation is conducted with states and territories regarding national harmonisation of NFP regulation.

Susan Pascoe, a former commissioner with the Victorian State Services Authority, has been appointed Chair of the Implementation Taskforce for the ACNC. The Implementation Taskforce will ensure the ACNC is operational by 1 July 2012, and ready to commence consultation on a single general reporting framework and information portal requirements.

 

Reforms to not-for-profit tax concessions

As part of the 2011 budget the federal government announced a tightening of tax laws in relation to profits arising from business unrelated to charitable work.

The government proposed that income tax will be applied to the profits on unrelated commercial activities conducted by not-for- profit (NFP) organisations if they are not applied to the entity’s altruistic purposes.

Similarly, concessions from Fringe Benefits Tax, Goods and Services Tax and Deductible Gift Recipient benefits will not apply to unrelated commercial activities.

NFPs who engage in commercial activities, such as those undertaken through a subsidiary company, will need to examine how profit from that venture is applied.

Commercial activities that further a NFP entity's altruistic purposes, and small-scale and low-risk unrelated commercial activities, will not be affected by the reforms.

The reforms commenced on 1 July 2011 and will apply to unrelated commercial activities which started after 10 May 2011.

The government released a consultation paper in May seeking views on aspects of the proposed reforms.

 

Government advisory committee advocates simplification in remuneration reporting for executives

The Federal Government’s Corporations and Markets Advisory Committee (CAMAC) has handed down its report on the possibility of reducing the complexity of executive remuneration reporting.

CAMAC’s report, requested by government following the Productivity Commission’s December 2009 report Executive Remuneration in Australia, revises the remuneration setting framework seeking to simplify the incentive components of these arrangements.

Under section 300A of the Corporations Act 2001, listed companies are required to publish annually in the ‘Remuneration report’ section of the Director’s Report, various matters regarding the board’s policy for determining the nature and amount of remuneration of the key management personnel for the relevant financial year.

While CAMAC declined to make wide-ranging reforms to current reporting requirements, the committee has made specific suggestions to improve executive remuneration reporting, including to:

  • require companies to give a general description of their remuneration governance framework
  • permit companies to withhold commercially sensitive information concerning a performance condition,
  • provided that they disclose that fact and set out a general description of the omitted information
  • remove the requirement to use accounting standards methodology in remuneration reports
  • require the disclosure of all termination payments, identifying entitlement payments (amounts paid on termination that reflect statutory and other accumulated payments), severance payments (amounts paid specifically for termination, including gratuitous and discretionary payments) and postseverance arrangements
  • require disclosure, for each executive, of crystallized past pay (remuneration granted at some previous time and paid in the current financial year), present pay (remuneration granted and paid in the current financial year) and future pay (remuneration that is deferred to some future period).

A number of commentators have criticised CAMAC for not recommending more wide scale reforms to simplify the current complex reporting requirements and thus make remuneration reports easier to read.

A copy of CAMAC’s 130-page report can be accessed here.

 

ASIC advisory on remuneration reports

ASIC has issued an advisory to assist listed companies in preparing their remuneration reports for directors and executives as part of their annual reports.

Based on a review of 60 remuneration reports for listed companies for the year ended 30 June 2010, ASIC has identified a number of areas where disclosure to shareholders can be improved. These areas are:

  • the board’s policy on the nature and amount of remuneration of the key management personnel
  • the non-financial performance conditions in short-term incentive plans
  • explanations for why performance conditions have been chosen, and
  • the terms and conditions of incentive plans.

In issuing its advisory, ASIC is encouraging company directors to prepare this year’s reports with the overriding objective of explaining the relationship between the company’s performance and the remuneration of its executives.

While ASIC’s guidance is aimed at the listed company requirements, other entities might also voluntarily adopt the principles as part of a commitment to accountability and transparency.

A copy of ASIC’s advisory including examples of better disclosure provided by companies can be accessed here.

 

2011 Annual General Meetings subject to ‘two strike’ rule

The so-called ‘two strikes’ rule, which came into effect from 1 July 2011, will apply to the upcoming Annual General Meeting season.

Under the rule, shareholders will be able to vote to hold a general meeting to re-elect the board where the remuneration report has received a 'no' vote of 25 per cent or more from its shareholders at two consecutive annual general meetings.

ASIC’s guidance regarding the remuneration report (discussed above) is particularly timely given these reforms.

A number of issues are raised by the legislation including whether the chairperson, whose remuneration details are included in the remuneration report, is prohibited from voting undirected proxies on the remuneration report resolution.

The Government proposes to change the law during 2011 to clarify that chairpersons are permitted to vote undirected proxies in relation to their remuneration reports if shareholders provide express authorisation for the chairperson to vote such undirected proxies.

In the meantime, ASIC has recently released guidance on how companies can comply with the provisions in their current form. A copy of the guidance can be accessed here.

 

Superannuation and personal liability for directors

In the May federal budget, the Federal Government announced that directors will be personally liable for any unpaid employee superannuation from 1 July this year.

This liability not only includes the 9% superannuation guarantee contribution but also wider superannuation guarantee charges such as interest on shortfalls and any administration fees.

The Government’s aim is to improve tax compliance and reduce so-called ‘phoenix’ activity that prevents the ATO from recovering unpaid superannuation.

Already the ATO can issue a Director Penalty Notice requiring a director to ensure payment of certain taxation liabilities, typically PAYG deductions. If a director fails to ensure payment within 21 days, they are personally liable for a penalty equivalent to the amount stated in the notice.

Penalty notices will now apply to the superannuation guarantee charge.

 

Governance practice tips – Leading organisational culture from the top

There is fairly universal agreement that boards have key functions regarding: strategy, overseeing company performance, monitoring risk and compliance, the appointment and monitoring the performance of the CEO, accounting to stakeholders, and representing the company.

However, setting organisational culture rarely appears in the list of board functions. In fact, setting organisational culture is perhaps the board’s most important leadership function but to be effective the board must have its own positive culture.

History has shown that a number of companies have had sound governance structures, policies and processes but still fail in times of crisis. A robust governance framework needs to be supported by a board culture that enables and encourages directors to ask the tough questions required to fulfil their duties.

Below we highlight six hallmarks of boards which engender a positive culture in the boardroom and for the organisation as a whole.

  • Transparency and accountability - Like management, boards should be accountable for their actions. Directors also need to be accountable to each other through, for example, adhering to a code of conduct and declaring any activities that could constitute a conflict of interest with their duties as a director.
  • Diligence - Directors must commit the time required to understand the company, its business and prepare for board meetings and events.
  • Collegiality - A high level of trust and respect among directors is critical for the board to operate effectively as a collective decsion-making entity. As far as possible, boards should aim for consensual decision-making. However, irrespective of whether that has been achieved, once all directors leave the board room they all must abide by the decision of the board.
  • Constructively challenge - Directors must be willing to be candid in discussions and appropriately challenge management and each other on issues. The chairperson plays a key role in encouraging all directors to participate in discussion and ensuring that all issues and dissenting views are fully debated.
  • Continual improvement and renewal - The board and/or each director should have a professional development plan as well as a policy on board renewal to ensure that new skills and perspectives are brought to the boardroom.
  • Regular performance evaluations - Just as employees are expected to undergo performance evaluations, so should the board (as encouraged by the ASX Corproate Governance Principles and Recommendations). Importantly, outcomes from the evaluations must be acted on. Similarly, action must be taken when a director is not performing to the standard required.

In addition to these considerations, boards need to look beyond their own culture and ask what they know of the culture in their organisation. Apart from understanding and seeking appropriate leadership styles in the CEO and executive managers, boards can seek to influence organisational culture by:

  • leading by example in a range of areas such as accountability, diversity and budgetary restrictions
  • building constructive and positive relationships internally and externally
  • ensuring alignment in vision and objectives and showing support for management at board level when appropriate, and
  • ‘walking the talk’ of organisational values.

Boards seeking more information regarding board processes can contact Kerryn Newton, Managing Director of Directors Australia on 0408 735 529.

Disclaimer: This newsletter has been prepared by Directors Australia for the purposes of providing general information only.This newsletter and its contents should not be used or relied on for legal or other advice by any party. Each party's individual circumstances may change the effect and relevance of any matters raised.

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