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This article first appeared in Forum, The Edge Malaysia Weekly on May 6, 2024 - May 12, 2024

Directors’ duties with respect to financial statements

In 2011, in the case of Australian Securities and Investments Commission v Healy & Ors, the Federal Court of Australia delivered an important ruling and laid down important principles of law on the standard of care for the chairman and board directors. In this case, the court held that seven defendants (the CEO, who was also a director, and six non-executive directors, including the non-executive chairman) had contravened their statutory duty of care and diligence by approving the consolidated financial statements of the Centro Group.

Centro had two main businesses. Centro Properties Ltd and its controlled entities invested in and managed retail property. Centro Property Trust, Centro Retail Trust and its controlled entities were into fund management. For the financial year ended June 30, 2007, at board meetings attended by the defendant directors on Sept 6, 2007, the consolidated financial statements, which had failed to disclose significant matters, were approved. For Centro Properties Group, short-term liabilities of A$1.5 billion were classified as non-current liabilities. This was also done for guarantees of US$1.75 billion of an associate company that were given after the balance date. For Centro Retail Group, the financial statements failed to disclose a sum of about A$500 million of short-term liabilities which were incorrectly classified as non–current.

The court held that the central question in the case was “…whether directors of substantial publicly listed entities are required to apply their minds to, and carry out a careful review of, the proposed financial statements and the proposed Directors’ Report, to determine that the information they contain is consistent with the directors’ knowledge of the company’s affairs, and that they do not omit material matters known to them or should be known to them.

Expectations set out by the ruling

•    A responsibility to read, understand and focus on the contents of reports for which the law imposes a responsibility to adopt or approve.

•    To carefully read and understand the financial statements before they form the opinions which are expressed in the directors’ declaration.

•    If necessary, to make further inquiries if matters in the financial statements indicate the need for such inquiries.

The court viewed directors to be at the apex of the company’s structure and responsible for the direction of the management of the company and an essential component of good corporate governance. Board decisions have a profound impact not only on shareholders but also its stakeholders (employees and creditors).

Such an approach calls for reasonable financial literacy and application of knowledge which a director ought to have, being intelligent and experienced persons in the corporate world. Proper diligence also presupposes attentiveness to and focus on the matter at hand at meetings, whether at committee or board levels. While it is not expected that the degree of knowledge should amount to accounting literacy and specific reference to accounting standards and practice, nonetheless, when directors adopt and approve accounts, they should have a knowledge of the basic elements regarding classification of debts and post balance date events. Earlier cases have established that directors whether executive or non–executive are required to take “reasonable steps to place themselves in a position to guide and monitor the management of the company and have a reasonably informed opinion of the financial position of the company”.

It was argued in the Healey case that the voluminous board papers militate against their ability to scrutinise and spot errors. The court rejected this argument and enjoined that directors will have to devote more time to the task and that the complexity of the matter and volume of the material cannot be an excuse not to properly read and understand financial statements.

Delegation and reliance on subordinate officers alone cannot suffice to ameliorate liabilities. One may delegate but not abdicate. In the Healey case, the board’s failure to give sufficient attention to the content of financial statements and reliance on a representation letter from the CEO and chief financial officer is not in compliance with the law. The non-executive directors’ reliance solely upon management and an external adviser constituted an abdication of their responsibilities.

Chairman and audit committee chair

A question arises as to whether a non-executive director who occupies the position of chairperson of the board and audit committee is subject to enhanced duties of care and skill. In an important case, ASIC v Rich (2004), the court held in the circumstances of the case that John Huyshe Greaves, being a chartered accountant, who held both chairmanships of the board and its finance and audit committee, had special additional responsibilities. In a 2020 case, ASIC v Mitchell, the court held that a chairperson has the following responsibilities:

•    Primary function is to preside and exercise procedural control at board meetings.

•    Has no power and authority to manage the corporation; such power is to manage board meetings where decisions are to be made and so has greater responsibility for the performance of the board as a whole

•    To ensure that the board has before it sufficient information to meaningfully consider and discuss agenda items, taking into consideration the context of the decision required.

•    Power, authority and responsibility to manage time for discussion of matters that merit closer scrutiny (for example, contentious matters) and for this purpose to arrange for meetings outside formal board or committee meetings so that relevant members of the board are thoroughly acquainted with the issues at hand to make the requisite decisions.

•    The effective working of board members with their diverse skill sets.

•    To engender collegial working harmonious relationships between board members and management, for example, the CEO

•    Responsibility for defining corporate culture, that is, the corporation’s set values.

•    Greater responsibility for defining and ensuring that the board sets and implements the corporate governance structure and mechanisms under which the processes are accountable to the board.

•    Assist in identifying new directors and the induction and orientation and continuing professional development of each director.

•    Responsible for monitoring the performance of board and committee members.

•    Ensure appropriate communications with members and stakeholders.

The finding of breach of duties and responsibilities of both non-executive directors and chairperson serves as a warning to holders of such office.

Philip T N Koh is an advocate and solicitor of the High Court of Malaya and adjunct professor of Universiti Malaya and the School of Business, Monash University Malaysia

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