The decision of the Federal Court in Australian Securities & Investments Commission v Healey & Ors [2011] FCA 717, relating to the 2007 accounts of companies in the Centro group, has no doubt raised anxiety levels for a number of company directors, concerned that they must now become experts in accounting standards.  While the decision certainly raises the bar for directors, the good news is it stops well short of requiring directors to be expert accountants.

While the Centro decision focuses on a company listed on the ASX, there are definite lessons to be learnt for directors, senior managers and others involved in governance of not for profit bodies such as companies limited by guarantee, incorporated associations, Aboriginal and Torres Strait Islander corporations and co-operatives.

The key messages from the decision for directors and other officers of not for profit bodies are:

  • approving the annual accounts is a core function of directors, for which they have specific responsibility under the Corporations Act – that responsibility cannot be delegated;
  • while directors are not expected to have a detailed knowledge of all accounting standards, they are expected to be financially literate and have a basic knowledge of key concepts, such as the difference between current and non-current liabilities;
  • while they can rely on others (internal and external) to prepare the accounts, directors need to review the accounts thoroughly and carefully, in light of the knowledge which they each have of the company's operations and financial position;
  • directors are expected to raise questions of management and the auditors, if there are any discrepancies or issues which become apparent as a  result of that careful and thorough review of the accounts; and
  • directors need to manage the volume of information which is provided to them, or the way in which it is presented, to ensure that they can maintain an appropriate level of knowledge of the company's operations without being overburdened with detail.  

The facts

The basic facts in the decision can be stated quite simply:

  1. the preliminary accounts lodged with the ASX by the Centro companies in August 2007 disclosed no current interest bearing liabilities. When the accounts for the year ended 30 June 2007 were prepared, some of the non-current liabilities were reclassified as current liabilities.   This change in classification was not specifically brought to the whole board's attention; 
  2. the final accounts did not accurately disclose the current liabilities of the companies. In respect of Centro Properties Group, the understatement of current liabilities was $1.5 billion and in Centro Retail Group, it was approximately $500 million. Those amounts were shown as non-current liabilities; 
  3. the directors had regularly been provided with information about the debt levels of the group companies, the maturity profile of the debt and the process of renegotiating debt facilities which had commenced shortly before the accounts were approved so they knew, or should have known, that the information in the accounts was not correct; and
  4. when the ASX queried the inconsistencies between the preliminary accounts, the published accounts and subsequent announcements relating to debt refinancing and maturity dates, the Centro group initiated a review of the classification of current and non-current liabilities and subsequently acknowledged that the classification in the accounts did not accord with the relevant accounting standard.  

ASIC brought civil penalty proceedings against each of the non-executive directors, the CEO and CFO alleging:

  1. breach of the duty in section 180 of the Corporations Act to act with care and diligence; and
  2. breach of the obligation in section 344 of the Corporations Act to take all reasonable steps to ensure a company complies with the accounting obligations in Parts 2M.2 and 2M.3 of the Corporations Act. 

These obligations apply to directors of all companies, not just listed companies. There are similar obligations which apply to those involved in the management of most other not for profit organisations.

The decision

What standard applies to directors?

The Court found that the directors had the following duties:

  • directors should have at least a rudimentary understanding of the business and the basic activities of the company and regularly review the accounts of a company to maintain their knowledge of the financial circumstances of the company;
  • directors need to have a level of financial literacy sufficient to understand basic accounting concepts and conventions;
  • they must read, understand and focus on each document that comes before them before it is signed-off, approved or adopted, taking account of the knowledge they have of the company's operations and financial position; 
  • directors must carefully read and understand the accounts before the accounts are approved; and
  • they must satisfy themselves that the information contained in the accounts is consistent with their knowledge of the company's affairs and make enquiries when the accounts are not consistent with this knowledge.  

Directors are not (necessarily) required to identify errors that subject matter experts, such as the external auditors, may have missed.

Applying this standard to the Centro situation, the Court found that, as the directors had knowledge, or ought to have known, of the debt maturity profile and the guarantees which were given after the balance date, they had breached the duty of care and diligence by failing to identify the discrepancies in the accounts (which the Court described as being "apparent without difficulty upon a focussing by each director and upon a careful and diligent consideration of the financial statements") and to raise the issues for further consideration.

While an individual may be appointed to the board of a not for profit body because of their particular skills (eg expertise relating to the body's programs), all directors have the same responsibilities and so need to ensure they are able to meet those responsibilities. 

Can a director rely on management and the auditors?

Yes and no. A director can rely on management and the auditors to prepare the accounts, subject to the usual qualification that reliance is not permitted if the director has reason to suspect the delegate is not reliable and competent.

However, when it comes to approving the accounts, the directors have an explicit obligation under section 295(4) of the Corporations Act, to declare that the accounts are true and fair and comply with the accounting standards. This requires the directors to actively consider the question, drawing on the knowledge they each have of the company's operations and financial position. While some reliance on the work of others to prepare the accounts is permitted, the directors have ultimate responsibility for approving the accounts and cannot delegate that role.

In the Centro case, the Court found that the board had not given the required level of active consideration to the accounts, so did not discharge their duties.

Managing information overload

There was evidence given by the directors about the large amount of information they would receive each month, and each director's practice in reviewing that information.

The Court suggested that the Board should control the amount of information which is provided, to ensure that directors can focus on key information which they need to be aware of. 

Given the complexity of many organisations and the diverse duties and potential liabilities imposed on directors, this is more easily said than done. It will be a challenge for management to decide:

  • what information to include and what to omit from board papers; or
  • what to include in "upfront" reports, rather than background or supporting papers,

in the quest to ensure directors have all key information readily to hand, but not too much information - not least because the key information omitted will always be identified with the benefit of perfect hindsight. 

The consequences

There are a number of steps which directors, management and advisers of all not for profit organisations can take, to avoid finding themselves in the situation of the Centro directors:

  • further education on financial literacy, key accounting concepts and the company's and director's obligations under Part 2M of the Corporations Act or equivalent legislation;
  • a very careful review of the financial statements and an "inquisition" of management and the auditors, before the financial statements are approved by directors, for any potential inconsistencies between the information which directors know about the company and the information disclosed in the financial statements; and
  • a focus on the extent of information which is provided to the board in advance of meetings or the timing of information being provided to the board, so that directors have sufficient time to review and digest the information before meetings.