Week 7 - Directors, Corporate governance, Financial reporting

These flashcards cover key concepts related to directors' duties, financial reporting obligations, auditor responsibilities, and major legal cases pertinent to corporate governance.

Test Applied (s180(1)) - Duty of Care and Diligence

An objective standard, often referred to as the 'reasonable person test,' applied to assess a director's actions based on a reasonable person’s expectations in their position.

Pro-active Management Requirements

Directors must be pro-active by:

• keeping informed about company matters;

• regular attendance at meetings;

• making their own inquiries (not just relying on others);

• and participating in decision making.

Knowledge Requirement (Daniels v Anderson)

Directors must understand the nature of the duty they are required to perform and be familiar with the business of the company.

Financial Statements in relation to Directors Duties (ASIC v Healey)

Directors have an objective duty to be able to read and understand the company’s financial statements. This is a non-delegable, primary responsibility.

Which section is the Business Judgement Rule found?

Section 180(2) of the Corporations Act provides the statutory basis for the Business Judgment Rule (BJR), offering a safe harbour for directors' decisions made in good faith.

Definition of Business Judgment (s180(3))

Refers to any decision made by directors regarding business operations, strategies, or other corporate matters as defined in s180(3).

BJR Condition (a) – Good faith/proper purpose

A director must make the business judgment in good faith for a proper purpose, acting honestly and fairly.

BJR Condition (b) – No material interest

The director must not have a material personal interest in the subject matter of the business judgment.

BJR Condition (c) – Informed decision

The director must inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate.

BJR Condition (d) – Rational belief in best interests

The director must rationally believe that the business judgment is in the best interests of the corporation.

What does Onus of Proof mean?

The responsibility on directors to provide evidence and prove that the Business Judgment Rule applies to their actions as a defense. The director bears the onus of proving that the BJR applies.

Where does the BJR not protect a director?

The BJR does not protect a director where the breach involves a failure to monitor the company’s affairs.

Case Example of Failure (ASIC v Adler)

BJR defence was unsuccessful as Mr Adler had a clear material personal interest in the relevant transaction.

Case Example of Limitation (Fortescue)

Decision-making regarding compliance with the Corporations Act (e.g., disclosure) is not considered a "business judgment".

Insolvent Trading Standard

The test applied is whether a reasonable director would have suspected insolvency. Directors must keep themselves informed of the company's financial position.

Record Keeping (s286)

All companies must keep written financial records that record and explain its financial position and performance.

Record Retention (s286(2))

Financial records must be kept for 7 years after the transactions covered by the records are completed (s 286(2)).

Annual Reports (s292, s301)

Large proprietary and public companies must prepare financial and directors’ reports and have them audited.

Financial Report Standards (s296–297)

Must comply with accounting standards (s 296) and give a “true and fair view” of the financial performance (s 297).

Half-Year Reporting (s302)

Disclosing entities (e.g., listed companies) must prepare and audit financial reports and directors reports half-yearly.

General Requirement (ss674, 674A, 675, 675A)

These sections outline the continuous disclosure obligations for listed entities, requiring them to immediately disclose material information.

Purpose (Continuous Disclosure)

Investor/market focused. Aims to prevent distortions in security price and promote fairness by ensuring equal access to information.

Material Information Test (s677)

A reasonable person will expect information to have a material effect on the price or value of securities if it would be likely to influence persons who commonly invest in deciding whether to acquire or dispose of those securities.

Timing Requirement (Listing Rule 3.1)

Must be disclosed immediately upon the entity becoming aware of it (Listing Rule 3.1). "Immediately" means "prompt and vigorous, without any delay".

Targeted Conduct Exclusions (Listing Rule 3.1A)

Non-disclosure, misleading disclosure, and selective disclosure are all targeted.

Information may be excluded if:

• disclosure would breach the law;

• it concerns incomplete negotiations or matters of supposition; or

• they are trade secrets.

Excluded information must also be confidential.

Enforcement Tool (s1317DAB)

ASIC may issue an infringement notice for alleged contravention of s 674(2) or s 675(2) (s 1317DAB). Penalties can be up to a maximum of $100,000 per notice.

Trading Halts (Listing Rule 17.1)

A temporary suspension of trading in a company's securities on the exchange, often initiated by the ASX pending a material announcement or to manage disorderly trading.

Auditor Role

To carefully examine company accounts so that any irregularities are exposed.

Independence (General) (s324CA)

A fundamental requirement for auditors to remain independent of the audited entity, avoiding actual or perceived conflicts of interest that could impair objectivity.

Independence Conflicts (s324CH)

Examples include: being an officer of the audited body; holding an investment asset in the audited body; or owing an amount to the audited body.

Waiting Period (s324CI/CJ)

A 2-year waiting period before an auditor (or partner directly involved in the audit team) can become an officer (management role) in a client company.

Rotation (s324DA)

An individual playing a significant role in the audit of listed companies must be rotated after a maximum of 5 successive years of service.

Auditor Statutory Duty (s307)

Forming an opinion on whether the financial report: (1) Complies with AASB (s 296 or s 304); (2) Presents a true and fair view (s 297 or s 305).

Reporting Contraventions (s311)

Auditor must report to ASIC if they have reasonable grounds to suspect a significant contravention of the Corporations Act.

Duty to Company (General Law)

A contractual duty to the company engaging them and a duty in tort to use reasonable care and skill.

Liability to Outsiders (Tort)

Liability may arise in negligence to outsiders (third parties).

Proximity Standard (Esanda v Peat Marwick)

Crucial issue is "proximity". Mere foreseeability of reliance is insufficient. The auditor must have known (or ought reasonably to have known) that the advice would be communicated to the outsider for a purpose very likely to lead them to enter into a transaction relying on the advice, risking economic loss.

Daniels v Anderson – Director/Auditor Duty of Care

A landmark case that clarified the objective standard of a director's duty of care and diligence, and emphasized an auditor's duty to warn management about accounting deficiencies or irregularities.

ASIC v Healey – Director Duty (Financial Reporting)

Directors have an objective and non-delegable duty to read, understand, and inquire about potential deficiencies in the financial statements. A knowledge of conventional accounting practice is necessary.

ASIC v Adler – Business Judgment Rule (BJR)

The BJR defence failed because the director (Mr Adler) had a clear material personal interest in the relevant transaction.

Esanda Finance v Peat Marwick Hungerfords – Auditor Liability to Outsiders

Auditors do not owe a duty of care to outsiders based on the mere possibility of reliance. Proximity requires the plaintiff to prove the auditor knew the information would be relied upon for a specific transaction resulting in potential economic loss.

Pacific Acceptance Corp Ltd v Forsyth – Auditor Duty of Care

A significant Australian case that established modern principles for auditor duty of care, emphasizing the need for auditors to be diligent, exercise professional skill, and actively verify information, not merely accept management's word.

ASIC v Fortescue Metals Group Ltd – Continuous Disclosure/BJR

The decision to not make accurate disclosure of a major contract is related to compliance with the Corporations Act and cannot be properly described as a business judgment for the purpose of the BJR defence.