Could civil penalties deter misconduct of director duties?

Professor Pamela Hanrahan discusses if increased maximum civil penalties for breach of directors' duties will deter misconduct in corporate governance.

Civil pecuniary penalties have been an important part of corporate regulation since the early 1990s. They allow for sanctions to be imposed on those directors who contravene their basic statutory duties when their failure is serious, but falls some way short of the level of fault — such as dishonesty — that would make it truly criminal.

The Australian Law Reform Commission (ALRC) described civil penalties in 2003 as a mechanism for responding appropriately to misconduct that did not merit the “moral and social censure and stigma that attaches to conduct regarded as criminal”. It said that: “civil penalties provide a means for the state to enforce breaches of laws without going as far as declaring all lawbreakers ‘criminals’”.

Civil pecuniary penalties for breach of directors’ duties can be ordered by a court on the application of the Australian Securities and Investments Commission (ASIC). They are payable to the Commonwealth and may be ordered on top of a requirement to pay compensation. Often, they are accompanied by orders disqualifying the person concerned from managing corporations. What is off the table is the stigma of a criminal conviction or the risk of imprisonment.

These pecuniary penalties are imposed in the court’s civil jurisdiction. This holds ASIC to the civil burden of proof (albeit subject to a high evidentiary burden, often described as the “Briginshaw standard”) requiring it to prove its case on the balance of probabilities, rather than beyond a reasonable doubt. Civil rules of evidence and procedure apply, and some of the processes and protections that operate to preserve civil rights and liberties in criminal prosecutions are not invoked. As the Full Federal Court confirmed recently in ASIC v Whitebox Trading Pty Ltd (2017) 251 FCR 448, ASIC does not have to prove fault elements such as intention or recklessness.

Against this background, it is significant that new legislation — the Treasury Laws Amendment (ASIC Enforcement) Bill 2018 (Cth) — introduced into parliament in October, lifts the maximum civil penalties for breach of directors’ duties. The fixed maximum of $200,000 (originally set in 1993) increases to the higher of 5000 penalty units (currently $1.05m) — or three times the benefit gained or loss avoided by the contravening conduct. Penalty units increase over time to ensure the penalties are indexed to inflation.

Calls to increase maximum penalties for what the government described as “corporate and financial services misconduct” had been getting louder for some time, and predate the revelations of the current Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. The Financial System Inquiry in 2014 had recommended that the penalties framework in Australia be revisited, shortly after the then chair of ASIC had called Australia a “paradise” for white-collar criminals.

In October 2016, the government established the ASIC Enforcement Review Taskforce to consider penalties and other aspects of ASIC’s enforcement powers. In April 2018, the government accepted most of the taskforce’s findings, but departed from its recommendation to cap the maximum civil penalties for individuals at 2500 penalty units (currently equal to $525,000). Instead, the government concluded that a “stronger response was necessary” — including a fivefold increase in the maximum fixed penalty.

So, will increasing the maximum civil penalties for breach of directors’ duties improve standards of corporate governance in Australia?

The answer is complicated. While governments will readily default to a “tough on crime” response (and media release), the criminology literature suggests that increasing the quantum of penalties does not have a marked effect on deterrence. In the area of white-collar crime (which typically involves deliberate wrongdoing) studies conclude that increasing the perception in people’s minds that they will get caught if they break the law is much more significant than increasing the size of the maximum penalty. In regulation, there is a trade-off in finding optimal deterrence, otherwise the danger is that companies and their directors will become excessively risk-averse.

The primary purpose of civil penalties is deterrence.

As the High Court said in Commonwealth v Director, Fair Work Building Industry Inspectorate (2015) 326 ALR 476, “whereas criminal penalties import notions of retribution and rehabilitation, the purpose of a civil penalty… is primarily if not wholly protective in promoting the public interest in compliance”.

Increasing maximum penalties in legislation only affects the deterrence balance if regulators bring enforcement proceedings and courts impose larger penalties in response.

Civil penalties proceedings against company directors are quite rare — ASIC’s quarterly enforcement report released in August 2018 indicates there are 22 civil proceedings against directors currently working their way through the courts. It is not inevitable that a civil pecuniary penalty will be ordered in every case, and when they are, they may be well below the statutory maximum. Empirical research by the Melbourne Law School, discussed in Company Director in May 2017, shows only 34 pecuniary penalty orders were made over the preceding decade. The average for a defendant with a single contravention was $25,000; for one with multiple contraventions, $177,875. In ASIC v Cassimatis (No 9) [2018] FCA 385, the pecuniary penalty requested by ASIC and imposed on the executive directors of Storm Financial (some 10 years after the company collapsed) was fixed at $70,000 each.

There is significant jurisprudence determining how judges fix appropriate penalties in particular cases. The statutory maximum is relevant, as it is in criminal sentencing. In Markarian v R (2005) 215 ALR 213, the High Court said that “careful attention to maximum penalties will almost always be required, first because the legislature has legislated for them; secondly, because they invite comparison between the worst possible case and the case before the court at the time; and thirdly, because in that regard they do provide, taken and balanced with all of the other relevant factors, a yardstick”. When parliament chooses to adjust the maximum, courts will take that into account in fixing future penalties. As the Victorian Court of Appeal concluded in R v AB (No 2) (2008) 18 VR 391, “Even where the offence to which the increase applies is nowhere near the worst category, the increase remains of relevance since, in the usual case, the increase shows that parliament regarded the previous penalties as inadequate”.

Under the new legislation, the maximum civil pecuniary penalty for breach of directors’ duties exceeds the maximum criminal fine for an offence under section 184 of the Corporations Act 2001 (Cth), which concerns reckless and intentionally dishonest breaches of directors’ duties.

This is government’s “stronger response”. Ultimately, its impact on standards of corporate governance will depend on the way in which it is applied by ASIC and the courts.