This address was recorded on 11 September, 2020, in the AICD's Sydney Business Centre and Member Lounge
Graham Bradley is a professional company director and is currently Non-Executive Chairman of United Malt, HSBC Bank Australia, EnergyAustralia Holdings and Shine Justice. He is a director of Hongkong and Shanghai Banking Corporation Limited and Chairman of Infrastructure NSW. He is a director of Tennis Australia and chairs Ensemble Theatre Limited.
Graham was made a member of the Order of Australia in 2009 in recognition of his contribution to business, medical research and the arts.
Full text of presentation
It is a pleasure to present the Essential Director Update again this year in our new format.
I was the born in the Year of the Rat and so I was much looking forward to 2020 which for we savvy, agile, adaptable Rats promised to be a special year of prosperity. Then along came a big Black Swan. Although Swans don’t appear in the Chinese zodiac, they must be the sworn enemy of the Rat!
For company directors, this has been a year like no other. A year in which we have all had to draw on our wits, our adaptability, our agility and our inventiveness to keep the wheels of our organisations turning safely.
It has been a year of new challenges, new risks, and for most of us, new learnings. I will try to capture some of those learnings in my presentation today.
My topics for today are as follows
- I will review how companies and boards have coped with the crisis and draw out some of the lessons from this experience.
- Major disruption to both corporate and national economies has required directors to focus closely on managing financial risk. I will discuss this key challenge.
- This crisis has occurred amidst a rising tide of public and regulator expectations for the role and responsibilities of directors. I will discuss the need to revisit what are reasonable expectations for we directors.
- Next, I will comment on proposed reforms to class action litigation, an area of exposure for directors in the spotlight during this crisis.
- The leading corporate governance-related litigation over the past year has been the Austrac case against Westpac for financial transaction reporting breaches with the regulator seeking multibillion dollar penalties. I will discuss the principles that should apply in cases such as this.
- Numerous regulatory relief measures were introduced to help companies manage through this crisis. It is time to ask whether these and other reforms should be permanently embraced to modernise company law and practice.
- And lastly, I will look ahead to 2021 with a series questions that directors should ask as we move into the post-crisis period.
My address will focus mainly on developments affecting large and listed companies and the lessons for director of companies of all kinds. Lisa Chung’s address will focus on recent developments in board accountability for corporate culture and reputation with particular reference to the NFP sector.
1. Coping with the Crisis: what boards have learned
Most directors I know have been pleasantly surprised how quickly and effectively their organisations have adapted to the need to carry on business in the face of government shutdowns and mandatory work from home policies. Aided by proficient access to home-based technologies, including affordable video conference platforms, many businesses have managed to remain productive with many employees working online.
Like many directors, I have learnt to navigate around Zoom, Microsoft Teams, Blue Jeans, Skype, Google and several other video conference platforms, and I think I am getting pretty good at it. It is now usually only two or three times per hour that I forget to ‘unmute’ myself! Requiring fellow directors around the virtual board table to stay on ‘mute’ unless called upon to speak is for many chairmen a very welcome innovation
Increased intensity of board oversight
Along with innovative ways of working has come a greater intensity of board oversight: more frequent board hook-ups to keep closer tabs on how organisations were coping, more detailed discussion of operating procedures, greater exploration by boards on how supply chains worked and more fine-grained discussion on operational risk factors. Directors have properly felt a duty to monitor how effectively management was looking after their employees’ and their customers’ welfare while “keeping the show on the road”.
Less happily, have come new learnings for directors in how to manage an almost total loss of revenue in an environment of what Lord Mervyn King has described as one of “radical uncertainty”. For example, as a director of a subsidiary of Virgin Australia, I have experienced my first voluntary administration. As a director of Ensemble Theatre, I have worked with management to implement redundancies, stand-downs, and applications for government relief and the challenge of rescheduling theatrical performances that were booked 18 months ahead. As a director of Tennis Australia, I have participated in ever-changing scenario analysis to determine how to preserve the organisation’s financial soundness in the face of possible inability to stage our main revenue-generating event, the Australian Open, next January. Every director I know has faced similar issues.
For me the standout lesson has been the importance of board and management working together as a team with considerably more intense engagement by directors in short-term operational management, beyond what is needed in normal times and beyond what will be needed in a post-COVID period. This crisis has demonstrated, however, the great advantage of Australian directors’ willingness to engage during a crisis and it is a strength of corporate governance in this country.
Innovation and Agility
A second learning is that our organisations have demonstrated remarkable agility in adjusting quickly to unprecedented constraints. Within a couple of weeks, for example, the HSBC Banking Group globally had almost 200,000 of its 260,000 employees working from home, including large numbers in its Indian and Philippines service centres. Tens of thousands of laptops were acquired and quickly configured to allow this to happen. Another company I know had a six-month programme begun before the shutdown to adapt Zoom as a global VC system with all the required security and encryption. This programme was put in place in just one week! Many organisations have surprised themselves and their boards with just how quickly things could be done when necessary. An interesting question for directors is whether the same agility can be harnessed in more normal times.
Good corporate culture matters
The ability of organisations to adapt to working from home and other safety requirements such as social distancing, split team operations, staggered working hours and the like has been a true test of the strength of corporate culture. By and large, boards have found that they had strong cultures where people were prepared to work flexibly and to remain productive, and could be trusted to do so. Remote operations depend upon a high degree mutual trust with employees, but my observation is that most boards have not been let down, although the strength of interpersonal relationships and culture will weaken if time away from the office is prolonged. For this reason, unlike many commentators, I doubt that we will see the death of the office in the post-COVID era.
Another great strength for many companies has been good customer and supplier relations, something that has been put to the test by supply chain disruption and product shortages in some cases. Many companies have, however, taken the opportunity with board support to provide hardship relief of one sort or another for customers, and have accelerated supplier payments, especially for small suppliers. All of this will pay dividends in the post-COVID period, and may go some way towards rebuilding public regard for corporate Australia, particularly in financial services, utilities and other disparaged sectors.
Did our risk management policies work?
Over recent years, boards and risk committees have spent countless hours poring over detailed risk registers and risk management policies. How many of them, I wonder, identified a global pandemic as anything but a high consequence but extremely low probability risk? Many companies that were adversely affected by SARS found they had ready-made plans and strategies in place to facilitate remote working, quarantining of key personnel, and other business interruptions. Some lucky companies may have even enjoyed business interruption insurance that covered pandemics, something I doubt we will see available in the insurance market in future years. My experience suggests that even companies that did not identify a pandemic as a risk for which they could and should plan were nonetheless able to adapt quickly to the crisis by drawing on their general contingency plans. Winston Churchill once famously said “planning is everything: plans are nothing”. This pandemic has, for many boards, proved this rule. Boards will spend more time in future thinking about potential black swan events rather than fine-tuning plans to mitigate lesser risks.
Heightened liability risks
Another area of risk relates to corporate reporting and disclosure and the challenge of crafting useful reporting about business outlook in these circumstances so as to have demonstrably reasonable grounds for any material statements the company wishes to make.
Along with all this has come heightened potential director liability for such things as providing a safe work environment for employees, maintaining vigilance against fraud and cybercrime (e.g. targeted phishing and identity theft) which can be harder to detect with a dispersed workforce, and, of course, the challenge of maintaining solvency. That brings me to my next topic: managing financial exposure.
2. Managing Financial Exposure
For many directors, the liquidity crisis of the 2008/09 “Global Financial Crisis” is seared in the memory. The GFC taught governments and central banks the importance of liquidity, and they acted more promptly this time to ensure that credit markets were closed only briefly.
Many Australian companies have acted quickly in early 2020 to raise equity or drawn down debt facilities to ensure that they had cash to see through an uncertain period of reduced sales revenues and potentially increased costs. Paying attention to cashflow and cash resources has been a key focus for directors, and investors have paid particular attention to the risks of short-dated debt refinancing.
For public companies that raised capital, recent temporary ASX relief (now extended to 30 November) has facilitated rapid non-renounceable private placements (now up from 15 percent to 25 percent of issued shares without shareholder approval) coupled with share purchase plans for retail investors where the maximum offer has been increased from $15,000 to $30,000. This higher SPP limit has partially assuaged criticism from retail shareholders who feel disadvantaged by institutional share placements at discounted prices. There is more general acceptance now by investors than there was a decade ago that rights issues are problematic in volatile and uncertain markets as we saw in the early months of this year, although ASX has required reports on how institutional placements were allocated.
Many companies have raised equity capital without being able to make clear statements to investors as to their business outlook, but Australian investors have avidly supported raisings and in some cases both institutional and retail investors significantly oversubscribed these placements in order to strengthen the balance sheets of companies for whom they saw temporary pain but long-term gain. Many boards have faced the challenge of deciding how much to scale back SPP applications—a high quality problem to have!
Market guidance relief
In March, ASX issued guidance to relieve the risks to directors regarding earnings guidance. Many companies have withdrawn their earnings guidance, and it may be some time before many of them are brave enough to issue new guidance. In May, the Federal Treasurer used his COVID emergency powers to introduce temporary amendments to the Corporations Act to protect companies and their directors in relation to continuous disclosure. Under the relief which has been extended to March 2021, companies and directors will only be liable for continuous disclosure breaches if they had knowledge or were reckless or negligent when disclosing or failing to disclose price sensitive information to the market. This protection recognised the challenge faced by directors in making meaningful and accurate disclosures in the face of the extreme uncertainty surrounding impact of the pandemic, particularly where disclosures provide or imply forecasts that are later found to be inaccurate. The changes make it harder to bring an action against companies and directors but maintain the requirement for accurate and timely continuous disclosure. The AICD strongly supports these amendments, and many would argue that they should become permanent.
Under Sections 674 and 675 of the Corporations Act, the ASX’s continuous disclosure listing rules have the force of law and breach attracts civil penalty provisions under the Act. Under the recent amendments, those penalty provisions will only apply where information is withheld from disclosure with knowledge that it would, or recklessness or negligence as to whether it would, have a material effect on the price or value of the entity’s securities.
Before the introduction of these temporary measures, our continuous disclosure regime was more onerous than most in the Anglo-American world. Giving the ASX continuous disclosure rules the force of law is not a feature of regimes in other major jurisdictions. It creates a right for a person who suffers loss as a result of contravention of the listing rules to seek compensation from a company or its directors, including by way of class action, and Australian directors do not have a “safe harbour” defence as would be the case as applies, for example, in the US or Canada where liabilities are excluded where forward-looking statements are identified as such and accompanied with cautionary statements.
Moreover, in other jurisdictions the plaintiff would need to show not only that the statement or disclosure is misleading, but that it is culpable in the sense of being deliberately dishonest, reckless or negligent. The recent changes return to a situation that prevailed before amendments to our Corporations Law made in 2001 and restores the need for culpability. Many feel that the 2001 changes opened the floodgates of litigation; many feel this temporary change should be made permanent. Treasurer Frydenberg has said he is open-minded on this possibility and has now extended the relief until 23 March 2021.
Despite these changes ASIC in July announced that it expected boards in this reporting season to make a clear statement about the financial impacts of the COVID crisis—good and bad—in their Operations and Financial Reviews, including “any risks and uncertainties, key assumptions, management strategies and future prospects”. That’s a tall order for companies faced with “radical uncertainties”. (ASIC generously allowed an extra month for filing statutory reports to enable companies to address these issues!)
Reporting “underlying earnings” (earnings adjusted for one-off items) will be particularly challenging this year and boards need to consider with extra care any statements they make about future outlook to avoid misleading the market.
The AICD together with Chartered Accountants ANZ and CPA Australia has published a Guide on how boards can navigate their financial reporting obligations during the COVID emergency. It sets out specific questions that directors may wish to ask management and auditors when finalising accounts.
Meanwhile, many companies will take a very hard look at whether they can in the current circumstances justify extra provisioning for current and anticipated costs and losses, and can and should write down asset values knowing that investors will be more understanding of such events this year than they would be in a normal year.
Temporary insolvency relief
Early in the pandemic, the federal Treasurer used his emergency powers to support companies facing short-term insolvency issues to give relief for directors from Australian’s draconian insolvency laws by pausing insolvent trading liability initially for six months but now extended to 31 December, 2020. The government also increased temporarily the minimum unpaid debt amount which can ground of a winding up proceeding from $2,000 to $20,000. The insolvency liability relief is helpful but is time-limited. JobKeeper and other government support programmes have kept many companies solvent but many of these programmes are coming to an end, and directors will need to look carefully at their situations once this occurs.
The amendments to the insolvent trading laws introduced in 2018 may help many companies by providing a defence from insolvent trading if a company has developed a “reasonable plan that will lead to a better outcome than insolvency”, adopted in good faith, and prudently supported by advice from an independent financial advisor. Nonetheless, the risk of severe personal liability for company directors whose companies trade insolvently has by no means gone away.
Many believe the government should consider more permanent changes including adopting elements of the USA’s Chapter 11 alternative to liquidation or voluntary administration. We shall see.
What boards should look out for
There are a number of things a board should watch closely in these uncertain times that may help avoid unwittingly trading insolvently. Remember that a company can be properly judged to be a going concern but nevertheless trade insolvently. Here are some of these red flags:
- Focus close attention on cash and cashflow and receive more frequent reports. Recall the One.Tel case where the court indicated that prudent directors of a company with severe insolvency issues should at a minimum receive weekly cashflow statements, not monthly.
- Take a good look at debt repayment trends. Is there an increase in delinquency and aged debtors, and is the credit quality of debtors adequate to ensure collection?
- Monitor the company’s payments to suppliers to ensure that management is not delaying payment to creditors excessively to preserve cash, a technique that may hide incipient insolvency risk.
- View spikes in revenue with caution, such as those experienced by some retailing companies during periods of panic buying, lest these “sugar hits” fade or reverse rapidly, leaving unsustainable costs and inventories in place.
- Bring a degree of scepticism to management’s forecasts lest they be over-optimistic about the recovery of business flows.
- Test carrying values of assets, make impairments where necessary, and look to the adequacy of provisioning, for example, bad debt provisioning.
- Last, review carefully ongoing and proposed capital commitments lest these over-stretch the company’s solvency and its financing lines and resources.
In summary, this is period when directors must pay closer attention to financial metrics and levers than ever before.
3. Revisiting “Reasonable Expectations”
Despite the COVID crisis it seems that around the world the expectations of director performance continue to mount year-by-year. The European Central Bank recently reported that in the 10 years to 2019 the total costs of fines and remediation on the part of European banks has now exceeded €350.0 billion, 15 percent of the combined market value those institutions. The expectations on the part of both investors and regulators for directors to actively demonstrate their commitment to corporate values and reputation is coming into sharper focus with every passing month. The recent events at AMP and RIO which Lisa Chung will discuss in greater detail in her presentation underscore these rising community expectations.
The most publicised regulatory action against a major public company in 2020 has been the Austrac v. Westpac prosecution arising from the self-reported failure by Westpac to notify millions of small international fund transfers made through correspondent banks over the period 2013—2019. The Austrac proceeding attracted prejudicial headlines by announcing that it would pursue Westpac for 23.0 million breaches of its anti-money laundering/counter terrorist financing reporting obligations, some small number possibly connected with payments by Australians related to child sexual exploitation in the Philippines.
While the overwhelming majority of the transactions in question (some 99.5 percent) were legitimate and uncontroversial transactions, such as inbound payment of pension monies to Australian residents or remittances to families of migrant workers, the headlines created by the case left the impression that millions of suspicious transactions have fallen through the reporting cracks.
Austrac has reportedly sought a negotiated penalty in excess of $2.0 billion, which Westpac is contesting. Meanwhile, both the chairman (Maxsted) and the chair of the Audit & Risk Committee (Crouch) resigned under political and investor pressure, but not before the board appointed an independent advisory panel chaired by Ziggy Switkowski (together with Kerry Schott and Colin Carter) to report on whether there was a sound basis for Austrac’s allegation that the board had provided “inadequate oversight” of the bank’s AML/CTF programme.
The panel’s report was released publicly in early June. It is well worth reading. It raises important issues about what constitutes adequate oversight by boards where unintended regulatory breaches occur as a result of undetected software errors that the organisation’s controls failed to catch, in this case for several years. The same question can be asked in relation to breaches of codes of conduct or actions inconsistent with stated corporate values that are not effectively escalated to the board.
The review panel found that financial crime compliance had until 2017 comprised a relatively small item on the risk agenda for the bank’s board and risk committee. Echoing the 2018 APRA/CBA report, with which all directors should be familiar, the panel found that, although reporting on financial crime was regular, the “voice of financial crime risk” was not loud enough at the board table. Nor were concerns raised by the regulator sufficiently clear and loud, a finding which should cause all regulators to review the quality and directness of their communication with regulated entities and their boards.
The panel noted that the Risk Committee’s agenda was a large one, with typically 35—40 items. Meetings typically involved around 40 participants, including guest presenters. It found the committee was conscientious and hard-working, but that the content of the information on financial crime reporting provided to it was not up to scratch. The panel, however, found no evidence of executives not reporting material matters they knew about or sugar-coating issues. Issues were quickly reported to the board and to the regulator once identified. The panel found no evidence that greed, self-interest or remuneration incentives played any part in Westpac’s failures. Its sins were ones of omission, not of commission.
Importantly, the panel concluded that for failings of this kind which occur deep in the organisation, it is not reasonable to expect that the board would find these out when information provided to the board and accepted in good faith was unintentionally incomplete. It was reasonable, however, to expect that directors would react with urgency once reports ‘red-flagged’ material issues.
On the question of what boards can and should be expected to do, the panel noted society’s steadily increasing expectations which, they said “are not necessarily well-founded” on what boards are set up to achieve.
We have yet to see how this case will play out, but the lessons for directors are that we should all look closely at any and all regulatory reporting requirements, and do what we can to test whether internal controls are well-designed to highlight any failings and to ensure that failings are escalated rapidly and then monitored closely and remedied with a demonstrated sense of urgency.
This case reminds us of the duty of every director under Section 180(1) of Corporations Law to “exercise his or her powers with the degree of care and diligence that a reasonable person would exercise if they were a director … of a corporation in the corporation’s circumstances”. This is a very wide and challenging statement of the obligations of directors of companies of all kinds, commercial and non-commercial. But this duty is qualified by the words of Section 180(2) which provides that directors who make business judgements are taken to meet the requirements of Section 180(1), and their duties at common law and in equity, if they:
- Make judgements in good faith for a proper purpose, and
- Do not have a material personal interest in the matter of the judgements, and
- Inform themselves about the subject matter of the judgements “to the extent they reasonably believe to be appropriate”, and
- Rationally believe that their judgements are in the best interests of the corporation.
The section goes on to say that a director’s belief that a judgement is in the best interests of the corporation is a rational one “unless the belief is one that no reasonable person in their position would hold”. It is clear from the legal cases that non-executive directors are not subject to the same high standard as executive directors who are expected to know more about the company’s operations. Moreover, case law makes it clear that, in assessing what care and diligence a “reasonable person” would exercise, courts will look at what a reasonable, ordinary person (meaning not skilled in a particular discipline or profession) “having the same skills and knowledge” would do in the circumstances. In other words, to breach Section 180 requires negligent conduct, not a mere mistake, or failure of enquiry about or fully comprehend technical issues that is not unreasonable in all the circumstances. This might include within a large company reasonable reliance upon the company’s management and control systems designed to ensure regulatory compliance.
One problem with Section 180(2) is that it requires an actual “business judgement” meaning an actual decision to take or not take action. It does not explicitly cover mere omissions or oversights, however excusable they may be. Hence the merit in proposals by the AICD and others to legislate in our Corporations Law a more wholistic business judgment defence for honest and diligent directors.
We have yet to see how these issues may play out in the Westpac case. Regardless of the outcome, senior and well-regarded company directors have been forced to resign in the face of the Austrac allegations.
In another court case involving Westpac over the past year, ASIC was comprehensively rebuffed in its attempt to justify a negotiated penalty of $35.0 million for alleged breach of responsible lending codes in relation to some hundreds of thousands of mortgages written by Westpac over many years. Perram J. found no breach of the codes in the now famous “Shiraz & Wagyu Beef” judgement. The Court of Appeal agreed and ASIC did not appeal. This case appears to be one of overzealous regulation, overly prescriptive and unsupported by clear legislative footings.
A similar defeat was suffered over the past year by the ACCC in its attempt to the block the merger of Vodaphone (a weak number 3 mobile competitor) and TPG (a non-participant in the mobile market) on the basis that a substantial lessening of competition in the mobile phone market would occur because TPG, against its stated strategic intentions, might create a fourth competitor in the market if the merger were blocked. This was a somewhat subjective counter-factual claim that the court rejected.
Another drawn out merger ACCC fought in court and lost was the merger of Seven Network and Bauer magazines—a mere $40 million merger—where ACCC seems to have failed to recognise the diminished role of newsstand magazines in the era of electronic media.
ASIC v. Mitchell
Another recent case was a notable, almost comprehensive loss on the part of ASIC but is a case which provides guidance on what constitutes care and diligence on the part of directors. This is the case of ASIC v. Mitchell where ASIC prosecuted Tennis Australia’s former President, Steve Healy, and former Deputy President, Harold Mitchell, alleging breach of their duty of care and diligence in relation to the renewal of Tennis Australia’s domestic broadcasting licence in 2013. I joined the Tennis Australia board well after the relevant events but I have observed this sorry story at first hand. Justice Jonathan Beach delivered his judgement on 31 July, and I commend it to you—all 440 pages! ASIC’s investigation had extended over four years, involved over 20 witnesses, and the court hearing lasted 19 days. ASIC lost 100 percent of its claims against Healy—dismissed with costs—and lost 93 percent of its 44 claims allegations against Mitchell. Not only did the judge find that Tennis Australia had suffered no damage as a result of the three minor infractions where Mitchell had “crossed the line” in his good faith attempt to negotiate the best possible deal for Tennis Australia, without any other personal interest. He found that ASIC’s construction of the evidence displayed “confirmatory bias” and that its “various coverup and conspiracy theories … turned out to lack substance”. ASIC’s case was described as “a questionable narrative”, “hopeless”, “spurious”, “muddled” and “a penny dreadful narrative”.
In his judgement Beach J. made some very useful comments about the role of the chairman of the board. After observing that the job description of a chairman (president in this case) was “not to be found in the constitution or in its desiccated provisions and phraseology”, but rather in common law and practice, he made the following points:
- The chairman is not entitled to completely delegate his functions to the CEO to determine the amount and quality of information to be put before the board to deal with any particular agenda item. But if he is satisfied that the CEO has exercised an appropriate judgement, he is entitled to rely on it.
- Nevertheless, the chairman must make sure through “prodding and asking questions at the meeting” that management has presented (orally or in writing) what is both necessary and sufficient for an agenda item to be properly considered by the board.
ASIC alleged that Chairman Healy had breached his duty by failing to disclose certain information and documents to the board. The judge found that it was reasonable for the chairman to have relied on management to put in place the necessary information flows and reporting systems. The chairman has (quote) “no power or authority to manage the corporation … he is not some sort of directorial overlord. But he does have the power, authority and responsibility for setting the agenda items, in agreement with other directors and in conjunction with management, and to ensure that the board has before it sufficient information to meaningfully consider, discuss and decide the agenda items”. The judge further elaborates on the role of the chairman in some very useful passages which I commend to you.
The judge made a further important point about Section 180. In order to constitute an act or omission contravening the section, there must be reasonably foreseeable harm to the company caused thereby which must be balanced against the potential benefits that could reasonably be expected to accrue from the conduct in question … (quote) “The very nature of commercial activity necessarily involves uncertainty and risk-taking … an activity that might entail a foreseeable risk of harm does not of itself establish a contravention of Section 180”. Moreover (quote), “a failed activity pursued by directors which causes loss to the company does not itself establish a contravention of Section 180 … On the other hand, the concept of harm should not be confined narrowly and Section 180 does not require proof of actual loss to a company. The risk of foreseeable harm is not confined to financial harm, but includes harm to all interests of the corporation … The legislators did not intend to dampen business enterprise and penalise legitimate but unsuccessful entrepreneurial activity.”
This particular passage is cause for contemplation in the context of the recent issues at RIO—serious risk of reputational harm—and AMP—risk of negative investor sentiment.
Perhaps it’s time for regulators to embrace rather than retard innovation and its economic consequences. For directors interested in how to inspire innovation in their organisations I commend Matt Ridley’s new book “How Innovation Works”. Ridley’s fascinating history of the major innovations that have most transformed our world over the past 200 years from the steam railway, to the electric light, to inoculation against disease have all suffered years of delay due to regulation, much of it promoted by regulators to protect incumbents. A great example is the mobile phone which was delayed in America by the US Federal Communications Commission which refused to allocate unused radio spectrum to cellular telephony from 1947 to 1984—nearly 40 years! Who says the pace of innovation today is breathtaking? Imagine how different our world might have been if mobile phones had appeared in the 1950s. (A lot quieter and less stressful I hear some of you thinking!)
We have to ask whether in the post-COVID era it isn’t time for regulators to back-off marginal cases, and to temper their zealous embrace of Kenneth Hayne’s injunction “why not litigate?” given that the errors and breaches identified by the non-judicial Hayne Commission are unlikely to recur any time soon. Arguably these now historical and largely remediated failings have been subsumed in the more pressing necessity for our major financial institutions to make major sacrifices to their earnings in order to support customers through the current economic crisis. It is now time to ask not “why not litigate” but instead “Why now litigate?”
Helpfully, key regulators, including the Council of Financial Regulators, have paused some proposed new regulations to help companies focus on navigating the COVID-crisis. If we can live without these new regulations in the midst of a crisis you might ask just how necessary they really are? For example, the Federal Government in March paused its Royal Commission implementation proposals for at least six months.
Another example is ACCC which has been authorising temporary cooperation agreements between COVID-impacted competitors in some sectors which would normally be considered to be cartel agreements.
This would in my view be an ideal time to revisit whether some of the proposals floated pre-crisis remain compelling. Two examples are the extension of the Bank Executive Accountability Regime to all APRA-regulated financial institutions—with increased and more stringent features. Another example is the new breach reporting requirements proposed by Treasury for holders of Australian Financial Services licences that was put out for consultation in February, immediately pre-crisis. Under these proposals, financial companies would have to report (on pain of criminal penalty!) when they undertake informal investigations into possible “reportable situations” within 30 days of initiation of the investigation, even if those investigations ultimately disclose that no serious breaches have occurred. Surely the last thing our economy needs at the moment is increased regulation of this nature, particularly wide but vaguely expressed “dragnet” regulation that will impose significant compliance and cost burdens upon all regulated entities.
4. Reforming Class Actions
In last year’s address, I highlighted the risk that royal commission-driven prosecutions, coupled with increased class actions against directors, were putting pressure on the availability and affordability of directors and officers’ insurance. That risk has well and truly landed in 2020.
Most company directors will have experienced increases in D&O insurance quotes of 200—400 percent as some major global insurers have withdrawn from participating in the Australian D&O market entirely, a market which, as I explained last year, has in aggregate been unprofitable for all insurers for over a dozen years.
Another factor affecting D&O is the fact that the legal liability regime imposed on Australian company directors is uniquely burdensome. Indeed, it is the most onerous in the Anglo-American world, as highlighted by a comparative study by Allens & Linklaters commissioned by the AICD in 2019 which is available on the AICD website.
In one company with which I am associated, the quoted cost of D&O for comparable cover increased tenfold over two years from 2018 to 2020, and the quoted premium would have equated to about eight times the aggregate fees paid to directors. Unsurprisingly, many boards have been forced to reduce the extent of cover they can afford, opting for higher deductibles, lower aggregate cover and lower cover in particular for Side C insurance against potential derivative class actions.
What part class action litigation has played in promoting this affordability crisis can be debated but concern by the director community and government has been focused on this issue over recent months. The finger has been pointed at the high profits made by litigation funders supporting class actions in some cases and the meagre returns—often only about 40 percent of settlements—that flowed to successful plaintiffs.
Temporary relief on disclosure obligations
In response to concerns about disclosure-based class actions during the pandemic when company directors faced serious uncertainties, the federal government introduced a temporary amendment to the law to require culpability for a successful claim based on company disclosures during the period to the end of November, 2020. This temporary measure does not address the longer-term issues associated with class action litigation. Nor does it ban action against directors for misleading and deceptive conduct.
Ironically, until recently the only class action case that has come to judgement in our courts in the past 20 years—the Myer case—resulted in a draw. While Beach J. found that unguarded statements by Myer CEO on several occasions about Myer’s profit outlook were misleading, he found that shareholders suffered no damage because market analysts had discounted the over optimistic statements and the stock price was not as a result inflated. Each party paid their respective costs as a result of this draw, reportedly over $10.0 million for each side. Sometimes litigation funders make large losses.
Litigation Funding Reform
Before proceeding, let me make a personal disclaimer. I recently became the chairman of ASX-listed law firm, Shine Justice Limited, which has conducted a number of class actions over recent years.
Along with most commentators, including the Australian Law Reform Commission, however, I genuinely believe that there is a proper role for class actions in our legal ecosystem. The largest class action settlement in Australia to date was $494 million paid out to about 5,000 victims of the 2009 Black Saturday bushfires in Victoria—our worst bushfire event in terms of loss of life with 173 fatalities—brought against an electricity distribution company, SP Ausnet. Similarly, an important judgement handed down early this year against Johnson & Johnson companies promises to involve an even greater payout to some 12,000 Australian women whose health was seriously adversely affected as a result of the failure of J&J’s vaginal mesh insert product which the judge found had not been properly researched and tested, and was negligently sold to medical practitioners. This judgement is being appealed.
Without litigation funding, cases such as these might never see the light of day. So there is a legitimate place for third-party litigation funding, in my view. But reforms are needed, and a range of sensible reforms were set out in 2019 by an Australian Law Reforms Commission report and by a recent Productivity Commission report on the subject.
Yet another (this time Parliamentary) Inquiry is now underway to see what reforms are needed in this area. Meanwhile, the federal government has announced that litigation funders will be required to hold an Australian Financial Services licence which will impose certain responsibilities and duties on funders, including a “best interests of the client” requirement and each funded case will require a disclosure document akin to a managed investment scheme. We have yet to see how far this may go to address the real problems.
In its submission to the Inquiry, the ACCC strongly advocated the role of class actions as an adjunct to its enforcement role. Government cannot afford to pursue every potential claim, and so the ACCC actively encourages private class actions by making available to litigants the results of its enquiries, including those obtained under its mandatory investigative powers in processes which are not subject to the normal due process requirements that apply in courts of law. I have questioned the legitimacy of this approach on the part of ACCC and also ASIC which does likewise.
Sensible Reforms Needed
There is not time today to fully explore the reforms that are needed in this area. These include requiring all corporate disclosure-based class actions to be brought in the Federal Court to eliminate forum shopping, greater powers for judges to assess the reasonableness of litigation funding fee arrangements, judicial powers to avoid duplicate actions related to common events, and several others. We can hope that the current Inquiry will lead the government to introduce sensible reforms, along the lines of those advocated by the ALRC and supported by AICD in large part without “throwing the baby out with the bath water”.
In June this year, the Victorian parliament, in a first for an Australian state, legalised lawyers charging contingency fees in class actions in the Victorian Supreme Court—that is, fees paid as a percentage of judgements or settlements. Currently lawyers may act on a “no win, no fee” basis under which they are liable for all costs, including cost awards to defendants if they lose the case. Victoria’s controversial change to longstanding policies making contingency fees illegal (unlike the situation in the United States) has led many to fear an avalanche of litigation and continued unfair outcomes for plaintiffs. The Victorian government’s argument is, however, that it will expand access to justice for plaintiffs and may provide a lower-cost alternative to litigation funding.
This change is a classic case where national uniformity of policy would be a preferable outcome, but for the time being, Victoria may become the jurisdiction of choice for class action plaintiffs.
It is important to remember that the high fees earned by litigation funders (and potentially class action law firms using the contingency fee arrangement in the future) in some successful cases must be weighed against the cases that are brought but fail where the funder or the lawyers must pay all the costs and disbursements (including those of successful defendants) without recourse to their plaintiff clients. In other words, the economics of class actions cannot be looked at on a case-by-case basis but across a portfolio of litigation cases.
A final comment is that the AICD has made a controversial submission to the Inquiry proposing that ASIC should have a monopoly on disclosure-related class actions. It remains to be seen whether ASIC embraces such a proposal with relish, but many can see good reasons why it might not.
5. Penalties—what principles should apply?
The Austrac v. Westpac litigation highlights for me a major issue with Australian corporate regulation—what principles should apply when regulators or courts set penalties for compliance breaches? Austrac is seeking a penalty north of $2.0 billion. Is this reasonable, is it necessary, is it fair, and does it meet sensible community standards? Or is the ‘sky the limit’ whenever a company fails, for whatever reason, in regulatory compliance?
Overseas, we have seen huge penalties imposed on global banks for anti-money laundering failures and other regulatory breaches over recent years. One report indicated that US banks had paid US regulators over $50 billion in penalties in the last few years, and the Justice Department extracted a penalty of US$8.9 billion against Bank Nationale de Paris just four years ago, calculated on no other basis than that it represented one quarter of the Bank’s yearly profits.
With Australian regulators emboldened by the Hayne Royal Commission and by governments to pursue all corporate breaches rigorously, the question of how to negotiate and agree penalties will, unfortunately, confront many directors in coming years. Regulators across all sectors now feel political pressure to seek high penalties rather than agree to enforceable undertakings to correct compliance failings. But what principles should apply?
The Purpose of Penalties
While the circumstances of every case will be different, it turns out there is considerable legal precedent around the principles that should apply, and I am indebted to a thoughtful judgement by Justice Pepper in a recent NSW Land & Environment Court case, Environmental Protection Agency vs. GrainCorp, a company which I formerly chaired. The case involved 145 self-reported instances over five years of minor exceedances of permitted emissions from GrainCorp’s silos of certain fumigants resulting from an accidental mathematical error by the company’s compliance officers. Drawing on extensive case law, the judge outlined the public policy purposes for which penalties are legislated. The main ones include:
- To provide a strong incentive to protect the community from the risk of re-offence.
- To underscore accountability where deliberate wrongdoing or negligent conduct caused the breach.
- To recognise any actual harm caused to victims, and
- To remove unjust enrichment, if any, arising from the breach.
What Principles Should Apply?
With these key purposes in mind, courts have articulated the matters that they should consider to ensure proportionality of penalty to the objective seriousness of the breach, taking into account any intentionality, recklessness or negligence. Those considerations include:
Taking all these factors into account, in the GrainCorp case where 145 breaches could each have incurred a maximum penalty of $15,000, a total penalty of over $2.0 million, and where the EPA argued for a significant penalty, the judge decided that a penalty of $60,000 was appropriate but reduced this to $40,000 in acknowledgement of an early guilty plea and cooperation by the company.
These penalty principles were cogently articulated and supported by the ALRC in its final report on corporate criminal responsibility released just this month, a welcome report that stepped back from proposals to deem executives automatically liable for corporate failings, finding that (quote) “the case …to hold individuals liable (for) corporate misconduct has not been made”.
Regulators seeking penalties should respect these principles which courts are likely to follow.
Directors should be alert to the need to oversee management’s response to discovered breaches so that a basis for negotiating reasonable penalties is established. This requires, for example, a corporate culture and protocols that make it mandatory for regulatory compliance breaches to be escalated quickly and frankly to top management and to the board or a board committee, and to ensure timely self-reporting to the regulator, where appropriate. It requires boards to demonstrate urgent commitment to correction and remediation and to future compliance. It is also helpful for directors to oversee the tone of communication with the regulator to ensure that the breaches are appropriately put in context of the company’s commitment to compliance, the scale of the company’s compliance task and its diligence in investigating the root cause of the breaches. All of this will help set up the criteria that should be taken into account in setting a proportionate and not excessive penalty or, better still, an enforceable undertaking or other remedial action.
6. Modernising Corporate Law & Practice
One positive development during this crisis has been the degree of cooperation between levels of government on steps to minimise the adverse impacts of the shutdown and to assist businesses and their customers to survive the crisis. Many directors would like to see this spirit of cooperation extend beyond the reopening of the economy and lead to some fundamental improvements in federal-state cooperation and in law and regulation that would make for a more efficient, a less bureaucratic and less over-regulated economy, a more competitive business environment, and a more efficient and competitive corporate law as it affects directors.
The last few months have demonstrated just how many requirements under the Corporations Act are based on historical physical processes and paper-based systems which might more efficiently be facilitated electronically. Examples include the authorisation of electronic signatures on legal documents, the holding of virtual annual general meetings (until 21 March 2021), electronic regulatory filings, not to mention digital court hearings, virtual medical examinations (for example for injury compensation claims) and other crisis adaptations. There are many more modernisations that could be addressed: for example, some courts still only accept payments by cheques! (Remember those?)
Some of these measures implemented by the Treasurer under emergency powers and extended only for several months. Many should be reviewed and extended permanently.
Other temporary relief such as class action relief and insolvency relief should not be extended longer than is necessary.
In the post-COVID period, there might, perhaps, be a greater willingness by government to consider a range of other improvements that would make our corporate law and practice more competitive. These might include:
- Reconsidering the “100-shareholder rule” and requiring instead shareholders representing at least five percent of issued shares to call an extraordinary general meeting. This would inhibit nuisance attempts by activist shareholder groups to disrupt and destabilise companies.
- Introducing a more wholistic business judgement defence for directors under which liability would not result where directors’ conduct is honest and made in reasonable reliance upon information provided by management in circumstances where directors have no reason to doubt that information, or the competence and integrity of management. Such a defence is available in other Anglo-American jurisdictions, including the USA, the UK (under Common Law), Canada and New Zealand.
- Reconsidering the onerous liability on directors for deaths in the workplace where imprisonment or criminal fines can apply unlike in most other Anglo-American jurisdictions.
- Reviewing all laws that automatically deem directors to be liable (subject to their ability to prove any available defence) where corporations breach a law or regulation.
I also hope that, as governments review the genuine necessity for any and all additional regulation, they respect the need for adequate consultation with business and groups like AICD around properly researched regulatory impact statements.
Let us hope that government might now see some political capital in ensuring that we have a balanced and competitive approach to corporate governance and the role of directors in the period ahead.
7. Looking Ahead
Let me conclude today by posing seven questions that directors should ask as we head towards 2021--hopefully the year of rapid recovery.
- Did our corporate culture serve us well in this crisis? Were we able to adapt quickly, maintain productivity and employee engagement, serve our customers well, and avoid the risks that arise from a dispersed workforce working remotely? If not, what should be done to address any weaknesses that emerged?
- Can we embed and maintain newly found innovation and agility which companies have displayed in coping with the crisis? Can we rethink the speed with which our organisation can bring new products to market? Exploit and develop new channels? Implement new systems? And streamline corporate processes—including how boards and management communicate?
- Given the need for directors to engage more intensely in how the companies’ operations were managed during the crisis, did our directors understand our operations well enough to contribute constructively to this challenge? If not, how can we better arm our directors with knowledge to improve both our business strategies and our risk management?
- Do we need to change the companies’ operating business model radically? For some boards this will be crystal clear: changed consumer preferences will force changed business models. For others it will be less clear, but this question will merit serious discussion in the year ahead.
- Many management have worked extremely hard to cope with the last 12 months, and this will not likely be reflected in companies’ financial performance and in remuneration. In other cases, there may be windfall profits being made through circumstances unrelated to managements’ performance. Some 20 percent of ASX-200 executives took pay cuts during the pandemic to help preserve cash and in sympathy with stood-down employees, many of whom also took reduced pay and reduced work hours. In some cases the board did likewise. Typical reductions were 20 percent. While company financial results will be lower, many executives will have met some of their STI milestones (e.g. employee engagement, customer satisfaction, safety performance, etc.). By rights these achievements should be rewarded financially under STI plans but how should boards navigate the obvious challenges here: reduced financial performance (not caused by management) but outperformance on non-financial matters? Also, how should receipt of government support programmes affect pay outcomes? Many investors will now regret their support for ill-judged regulatory proposals to minimise the percentage of incentives based on financial measures! This once again demonstrates to me the merit of ensuring that remuneration plans include a high degree of board discretion.
- Is our management still looking at its feet and do we directors need to raise their sights to the horizon, and the opportunities and challenges of the post-COVID period? Are we leaving enough time in our board discussions for looking beyond the near-term to the very real challenges faced by most businesses over the next five years?
- Lastly, is our company ready for next Black Swan?
Those are some of my reflections on the year of the Big Black Swan. In many ways, however, this was not a black swan event in the sense that the possibility of a pandemic was not beyond imaging based on epidemics over the past 100 years such as SARS, Ebola and Spanish Flu. A global epidemic would sometimes appear on many organisations’ risk registers as a highly unlikely but catastrophic event. So, a pandemic wasn’t like the Australian black swan which on-one who had ever seen a swan in the rest of the world would have predicted. Our pandemic was totally predictable—a large and obviously dangerous probability—more Grey Rhino than Black Swan.
I am, however, happy to describe COVID-19 as a black swan. It takes the pressure right off the rat who was blamed, probably correctly, for the multi-century impact of the Black Death in Europe and other parts of the world in the 1300s—1600s. This time it was the bat and not the rat that caused the plague!
According to leading microbial ecologist, Peter Pollard, there are more viruses on earth than there are stars in the universe. Concentrations of viruses in fresh water lakes often exceed 100 million per teaspoon of water. Why and how this particular virus came to afflict us at this time and with this severity is a matter for future scientific review. Regardless of the outcome of that study, however, let us hope that we directors, and legislators and regulators with us, will have learned valuable lessons that will help us contribute more efficiently and effectively to the governance of our organisations in the future. Let us not waste this pandemic!