Going through the motions: What does the Centro decision mean for you?

03 August 2011 Topics: Compliance and corporate governance

In the recent Federal Court decision of ASIC v Healey [2011] FCA 717 Justice John Middleton ruled that Centro’s directors breached the Corporations Act 2001 (Cth) (Act) when they failed to notice significant errors in the 2007 consolidated financial statements of Centro Properties Limited, Centro Property Trust and Centro Retail Trust (CRT) (collectively, Centro).

In late 2007, Centro admitted that debt figures released in the 2007 annual reports were significantly inaccurate. Centro had incorrectly classified approximately $1.5 billion of current liabilities as non-current, and failed to disclose guarantees of short-term liabilities to an associated company of approximately US$1.75 billion.

CRT failed to disclose approximately $500 million of current liabilities, also incorrectly classifying the debt as non-current. The company’s auditors, PricewaterhouseCoopers (PwC) also failed to notice the errors. Middleton J held that the directors were aware of information that should have made them aware of the errors.

ASIC commenced proceedings against Centro’s directors, seeking declarations that the directors had contravened the Act. The court stated that there was no suggestion that the directors’ failure to recognise and take action in relation to these errors was intentional or dishonest.

THE KEY ISSUES

Misclassification of current liabilities as non-current

Company directors are obliged under the Act to review financial reports and declare whether, in their opinion, the reports comply with accounting standards and represent a true and fair view.

The question central to the proceeding was to what degree is a director required to critically review proposed financial statements, in order to determine whether they are consistent with the director’s knowledge of the company’s affairs and do not omit material matters.

The directors relied upon advice received from their finance team and PwC. While it was not unreasonable for the directors to trust this advice, the assurances of management and auditors do not absolve directors of having to bring an enquiring mind to a review of the financial statements.

It was held that directors must have sufficient financial literacy to understand financial statements, and knowledge of accounting standards to be aware of what must be included in them. The Act requires directors to form an opinion about the accuracy of financial reports – it is not possible for a director to form that opinion without such knowledge. Nor is it possible for a director to delegate that responsibility to management or auditors.

ASIC further alleged that Centro’s conduct contravened section180 of the Act, which requires a director to exercise his or her powers and discharge his or her duties with the degree of care and diligence that a reasonable person would exercise if that person was a director of a corporation in similar circumstances. Section 601FD(3) similarly applies to registered schemes, which was relevant for CRT.

Whilst there was no suggestion that the directors had acted dishonestly in carrying out their responsibilities (and to the contrary were clearly intelligent, experienced and conscientious people), Justice Middleton found that the directors had nonetheless contravened eections180 and 601FD(3) by failing to take all reasonable steps to ensure compliance with the Act, and had failed to exercise the degree of care and diligence required when reviewing the financial statements.

Post balance date events

Accounting standards require that companies disclose material events that may arise after the reporting date as they can influence the decisions people make on the basis of the financial statements.
It was held that Centro should have disclosed approximately US$1.75 billion of guarantees to a related business entity were due to mature within 12 months of the balance date. The magnitude of the guarantees and their effect on the assets/current liabilities ratio meant they were clearly considered material events.

Section 295A letter

The Act provides that a director can only make a declaration that the financial reports comply with accounting standards and represent a true and fair view after receiving a declaration of compliance by the CEO and CFO. Middleton J held that the letter issued by the CEO and CFO to the board did not, in form or content, comply with the requirements of the Act. Further, a simple reading of the relevant provision would have made it clear to the directors that the requirements had not been satisfied.

Therefore, Middleton J ruled that the directors did not take all reasonable steps to secure compliance with the reporting provisions of the Act.

WHAT THIS MEANS FOR DIRECTORS

The Centro case has highlighted that the task of reviewing company accounts demands critical and detailed attention, and cannot be satisfied by merely be ‘going through the motions’ or placing sole reliance on others, no matter how competent they appear to be.

Directors need to critically examine all financial reports, and consider them in relation to their own accumulated knowledge of company affairs and activities.

Directors must be sufficiently familiar with critical accounting standards to know what should be included in financial statements and whether there are any material omissions.

If directors are aware that compliance with certain provisions of any act is required they must take the time to inform themselves of the requirements as ignorance is no defence for failure to comply.

Consideration should be given as to whether directors are being presented with the most useful information. Provision of too much information may mean that directors are unable to focus on what is truly important – that vital details and warning signs may be lost in a mountain of paperwork.

If you would like further information on corporate governance issues please contact David Grace or Charles Sweeney on 07 3231 2444.

Authored by David Grace and Anna Richmond.

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