What directors can learn from the Crown Resorts inquiry

In fulfilling their fiduciary duties, directors must always act in the best interests of the corporation, writes Professor Pamela Hanrahan.

Directors often look to the decided case law to understand what their duties mean in practice. But sometimes other sources, such as the recent inquiry into the suitability of Crown Resorts Limited to hold a casino licence in NSW, can be an even richer source of guidance for boards.

As with the report on the Commonwealth Bank of Australia conducted for the Australian Prudential Regulation Authority in 2018, and the final report of the banking Royal Commission in 2019, Commissioner Patricia Bergin SC’s report into Crown opens the window on a culture in which a measure of financial success had masked or enabled catastrophic failures to manage non-financial risks, including integrity and compliance risks, and risks of harm to the company’s broader stakeholders.

Commissioner Bergin found significant failures relating to “Crown’s operations in China and the arrests of the employees in October 2016 — “with numerous failures” to escalate indicators of real risks to the staff to the proper decision-making mechanisms within the company; the probability of money laundering in Crown’s operations, both in the bank accounts of its subsidiaries, Southbank and Riverbank, and in the casino premises (with hundreds of thousands of dollars brought into the casino in cooler bags and shopping bags and exchanged for chips and plaques); and Crown’s failures to ensure it only had commercial associations with junket operators of good repute”.

The “stark reality”, according to the report, was that Crown “facilitated money laundering… unchecked and unchanged in the face of warnings from its bankers”. It “disregarded the welfare of its China-based staff putting them at risk of detention by pursuing an aggressive sales policy and failing to escalate risks through the appropriate corporate risk management structures” and entered or continued “commercial relationships with junket operators who had links to Triads and other organised crime groups”.

The casino inquiry was not directed at whether Crown or its board and senior management had breached their legal obligations in the past, either under the gaming laws or broader corporate law. While being law-abiding is relevant to the question of whether an entity is suitable to operate a casino, it is not the whole question. In Commissioner Bergin’s view, assessing suitability to operate a casino requires “an understanding of the character of the corporation”, involving “a recognition not only of its strengths, but also of its willingness to: (i) accept the existence of its failures; (ii) to analyse the reasons for such failures; (iii) to remove the cause of its failures; and (iv) to commit to a reformation that will remove the likelihood of a repetition of such failures”. The inquiry found Crown failed the suitability test, but left open the possibility of rehabilitation.

Suitability is about character. While noting the “pivotal importance of reliable executives and senior management”, Commissioner Bergin recognised that “the character of the company can in the main be understood through the conduct, attitudes and values of those who set its course. This is the board, including the CEO”.

What was at the root of the failures at Crown? In her final report, Bergin identified “structures in place that have contributed to the corporate failures”. These included Crown’s relationship with major shareholder Consolidated Press Holdings (CPH) and its owner, James Packer; Crown’s risk management structures and their resourcing; and “the governance and culture of the organisation”.

A question of loyalty

It is fundamental to directors’ roles as fiduciaries that they act at all times in the best interests of the corporation itself. In a solvent business corporation, the corporation’s interests are usually discerned having regard to the interests of the shareholders collectively, over the medium to long term, in investing in a law-abiding and sustainable business. It is not about doing what the largest or loudest shareholder wants. This is particularly true in a highly regulated business where, as Commissioner Bergin noted, there exists an “overlay of responsibilities to stakeholders well beyond just their shareholders”.

For at least some of the Crown directors, according to the report, their relationship with James Packer and CPH seems to have obscured that basic principle, and created “clearly a dysfunctional environment”. Commissioner Bergin concluded that “the corporate needs of Crown were not given precedence over the corporate needs or desires of CPH” and that “it is obvious that the real power was exercised by Mr Packer, both by reason of his personality and also the somewhat supine attitude adopted by Crown’s operatives”. The “remote manoeuvring” by Packer of Crown’s operations “was enabled by arrangements” — including a services agreement and a controlling shareholder protocol, not terminated until October 2020 — which provided Packer with confidential information not available to other shareholders.

Corporate governance principles emphasise the need for independence — and not just from formally “independent” directors. This goes beyond structures. A board member who is appointed by or beholden to a substantial shareholder still owes their duty of loyalty to the corporation itself, and must make decisions based on where the corporation’s interests lie. Those interests may coincide with those of a substantial shareholder, but they are not the same.

The inability of some directors to act independently of what they perceived to be Packer’s interests or wishes was obvious on the evidence, including in director Andrew Demetriou’s assurance to Packer — “I remain committed to serving the best interests of Crown, and most importantly, you”. Unsurprisingly, the Commissioner concluded, “it is imperative that this remote manoeuvring must cease for the health of the corporation”.

Risk management

The failures identified by the inquiry — the China arrests, the accusations about money laundering and the junket arrangements — also point to significant failures in Crown’s risk management structures and resourcing.

Commissioner Bergin identified risk management as “a core pillar of corporate governance”, involving a “critical, reciprocal relationship between board and management”. Consistent with the concept of setting the tone from the top, she concluded “the fundamental roles of the board comprise: setting the entity’s strategic objectives; setting the entity’s risk appetite; and overseeing management’s performance, including the execution of the entity’s strategic objectives”. The role of management, under the supervision of the board, “is to design and implement the risk management framework and ensure that the entity operates within the risk appetite. Management must also provide the board with sufficiently accurate and timely information for the board to perform its supervisory duties”.

What does this mean in practice? The risk appetite statement “cannot merely express aspirations of total compliance, but must articulate the board’s expectations in specific instances of non-compliance, such as consequences for breaches as well as escalation and rectification processes. A successful risk appetite statement includes organisation-wide engagement in designing the risk appetite statement, risk escalation and reporting protocols and the linking of remuneration and performance processes with risk management.”

What clearly emerges from the report is the failure of the Crown board to engage adequately with the real risks in the business. When a corporation — as Crown did for years — operates outside its stated risk appetite, “the board must exercise ‘active stewardship’ and hold management to account… A failure to do so suggests the board’s ‘tacit acceptance’ of operating outside risk appetite”. If information is not communicated to the board, or the board fails to appreciate the significance of the information, that is a failure by the board either directly or through the risk committee. A risk committee “should be equipped with sufficient size, independence, technical and industry knowledge and powers under its charter to fulfil its function. These powers include obtaining information, interviewing management, interviewing internal and external auditors and obtaining specialist advice.”

The response to the allegations about money laundering was a case in point. As Commissioner Bergin observed, “it was not until the denouement of the public hearings that Crown apparently formulated an idea that it would be a good idea to give some instruction to the Crown directors on the AML/CTF legislation and landscape” — training that former director Harold Mitchell boasted of having finished in half an hour. This was “13 months after the allegations were exposed in the print media, 10 months after Counsel Assisting opened the public hearings referring to the problems in the accounts and after months of what may reasonably be described as devastating evidence of the obvious indicia of money laundering within the accounts”.

Governance and culture

The third factor identified was failures of governance and culture, which the Commissioner described as “inextricably linked”. If governance describes the more formal structures and pillars by which accountability in the organisation is allocated, then culture is the informal norms and behaviours that determine how it plays out on the ground. As the Commissioner observed, many of the problems at Crown “stem[med] from poor corporate governance, deficient risk management structures and processes and a poor corporate culture”. Given the failures that occurred, the conclusion seems obvious. But how to fix it?

Culture cannot be ordered up, or measured, on demand. It is no answer for a board to adopt another document full of meaningless jargon. Commissioner Bergin challenged what she called “management speak”. Finding that “some of the proposed mechanisms for defining Crown Board’s appetite for its tolerance for risk events are impenetrable”, she observed that the fact that the Crown board “had not at the date of the conclusion of the public hearings of this inquiry on 20 November 2020, proffered evidence that it had attended to these problems is a real and deep impediment to the proper management and proposed cultural changes of the organisation”.

Culture includes process, but cannot be left to it. It is not a matter for consultants or metrics.

Road to rehabilitation?

Many have asked whether the purging of the whole Crown board would be required before the authority in NSW could regard Crown as suitable to hold the casino licence at Barangaroo. The same question may arise in the inquiries recently announced in Western Australia and Victoria. However, Commissioner Bergin concluded that “such an approach would be inappropriate if there is an available realistic alternative to accommodate due regard to the commercial imperative of the viability of a public company whilst achieving such conversion”. Context is everything.

Six directors left the board after the release of the inquiry’s report. A seventh has announced plans to step down. It is hard to resist the conclusion that the same blindness to the problems that led to the failures was evident in that response, in light of the excoriation several directors received in the report. Ultimately, the composition of the board is a matter for shareholders and it is difficult to see how an institutional investor properly discharging its stewardship obligations could favour the continued involvement of individuals who imperil the corporation’s very licence to operate.

For those who remain, and for directors in other corporations where significant failures have occurred, what happens next? The matters going to suitability identified by Commissioner Bergin — a willingness to accept the existence of failures, to analyse the reasons for failures, to remove the cause of failures and to commit to a reformation that will remove the likelihood of a repetition of such failures — must be the starting point.

Ongoing education helps. Legal liability, commercial accountability and ethical responsibility are all relevant considerations. Events at Crown suggest that critical reflection, integrity, humility, diligence and true independence of mind on the part of directors are more important than ever.