ASIC suffers two major setbacks

Professor Bob Baxt outlines two recent cases unsuccessfully pursued by the regulator and argues it is time that ASIC is provided with sufficient legal support.

While the Australian Securities and Investments Commission (ASIC) has been very active in recent months, initiating a number of high-level actions in our courts (including three actions against major trading banks for alleged rigging), as well as a number of prosecutions in other areas, it has recently suffered two major setbacks. One has come at the hands of the now retired Justice Robson of the Victorian Supreme Court in ASIC v Flugge & Geary [2016] VSC 779 (Flugge). The second was from Justice Edelman in one of his last judgments in the Federal Court (Justice Edelman joined the High Court in January 2017), in ASIC v Peter Drake & Ors [2016] FCA 1024 (Peter Drake).

The decision in Flugge is perhaps a bittersweet result for ASIC as it obtained one judgment in its favour against Flugge, who was the chairman of the Australian Wheat Board Limited (AWB). As we went to press ASIC announced it was lodging an appeal in the Victorian Court of Appeal against Robson J’s decision to dismiss all charges against Geary. This case flowed from transactions with the government of Iraq when it was subject to United Nations sanctions, with respect to trading wheat for oil. Justice Robson ruled that Flugge had failed to make appropriate enquiries about the propriety and legality of the relevant payments, which were made by the AWB.

In his view, the AWB had engaged in improper conduct in paying certain fees to the government of Iraq. He ruled that Flugge was in breach of section 180(1) of the Corporations Act 2001 (Cth) (the Act) – the failure to act with appropriate care and diligence. A number of other actions were brought by ASIC with respect to criminal sanctions, as well as civil sanctions, against Flugge, Geary and other officers of the AWB. These had been instituted following a high profile Royal Commission report prepared on behalf of the Australian Government (The Cole Enquiry) in November 2007. A taskforce had been established by the Australian Government to investigate various matters arising out of these aforementioned transactions.

ASIC failed in relation to nearly all of its criminal and civil penalty proceedings in the Supreme Court against a number of directors and officers. Justice Robson’s ruling against Flugge is regarded as a minor success for ASIC in obtaining a verdict that Flugge had breached his duty of care and diligence. Civil penalties – both monetary and disqualification orders – are now being sought by ASIC against Flugge. However, the cost of the investigations into the AWB scandal and the legal costs surrounding the various trials were enormous, and it is certainly not a result that ASIC would regard as a very satisfactory one in my view.

The Drake case

The second relevant decision, Peter Drake, involved ASIC’s prosecution of former directors of LM Investment Management Limited (LMM). Certain allegations were made that various directors of LMM had breached their duties by signing off on loans made by the company to Maddison State Pty Ltd, which the director Peter Drake owned and controlled in 2011. While some of the prosecutions in this case were settled by consent, the proceedings against Drake, Mulder and van der Hoven were continued.

Justice Edelman’s ruling that the directors had not breached their duties to act with the appropriate care and diligence (section 180 of the Act), and in respect of other matters arising under sections 181 and 182 of the Act, has caused quite a “stir” in the business and legal communities. In a lengthy judgment of more than 100 pages, Justice Edelman examined the circumstances of the various transactions, the subject of the allegations made by ASIC, and then turned to a careful examination of the evidence provided in respect of each of the claims.

One of the most interesting aspects of his judgment was his criticism of the failure of ASIC to produce appropriate evidence in establishing what alternative classes of conduct might have been engaged in by the defendant directors, in relation to the relevant transactions. In his view, ASIC, in examining the alleged breaches, should have posed alternative scenarios that might have been pursued by the directors and officers.

Apart from highlighting the deficiencies in the way in which the case was run, Justice Edelman was also critical of the fact that ASIC had not been able to produce expert witnesses in support of the allegations of the relevant breaches. It is not necessary to discuss the details of these failures.

However, in an interesting passage of his judgment, Justice Edelman illustrates the failure of ASIC to produce the type of evidence that is necessary in a matter of such complexity. Justice Edelman noted, at paragraph 542, that these matters “were not the subject of any detailed expert evidence. I have put them to one side in these reasons and treated the [relevant loan that was pleaded] in the way that it was treated in the evidence, albeit taking into account its terms as a loan to a special purpose vehicle which was designed not to profit from the development.”

This failure on the part of ASIC to provide appropriate evidence as to the steps that may have been taken in relation to the transactions, but also the “implosion of its expert witness” were highlighted. Justice Edelman, at paragraph 537 of his judgment, noted that the expert was unable to concede “even the clearest points, accepted that deciding whether something is a prudent decision to approve involves an identification of the alternatives and an assessment of the alternatives…But [the expert] singularly failed to do so and ASIC’s case followed suit.” There was confusion on the part of ASIC in terms of its claims for alleged breaches of duty and Justice Edelman noted that there had been a shift in the way in which ASIC ran its case with respect to the circumstances.

One other interesting aspect of Justice Edelman’s judgment was that it was unnecessary for him to deal with the arguments put forward by the defendants that they should be relieved of liability pursuant to sections 1317S and 1318(1) of the Act. He noted that it was unnecessary to decide whether relief would be given as this, “would depend upon the nature of the breach which had been found and the circumstances of the breach” (see paragraph 539).

Because the case had failed to establish that there was in fact a breach, it was unnecessary to provide a conclusion although Justice Edelman did note that the relevant directors who might be seeking relief had acted honestly in good faith for a proper purpose and in the best interests of the corporation. In those circumstances, had a contrary conclusion been reached by him on the evidence, he would have been inclined to conclude that each of the relevant directors be excused from personal liability.

A significant case

The case, which took a number of days to argue in the Federal Court, comprised a huge amount of evidence, arguments as to the way in which the evidence should be treated and a detailed discussion of relevant case law. As with previous judgments of Justice Edelman, it is full of very interesting observations about the interpretation of various provisions, not only of the Act, but also of trustee law which links so closely to the way in which corporations law should be interpreted.

The criticism levelled by Justice Edelman on the ASIC decision has been reflected upon by media reports and it is clearly a matter that ASIC will be considering very carefully in the next few weeks to determine whether they might seek to review the decision in the Full Federal Court. It will be a difficult case for those members of the Federal Court who might be asked to preside over the case.

ASIC, notwithstanding all the best will in the world, and the pursuit of high profile litigation, needs to obtain the very best advice and support of the best experts in running these difficult cases. ASIC should ensure that the court is only asked to review the relevant evidence and facts that it brings to the courts, based on appropriate legal advice and ensure that other issues are fully explored to the satisfaction of the relevant judges. Otherwise, cases will fail.

I have argued previously that our regulators should be provided with sufficient legal support so that they can retain the most qualified counsel and other experts in running these difficult cases. Time will tell whether such suggestions will bear fruit or whether we will continue to see a staggered approach to the way in which enforcement is taken in Australia in these critical areas.