December 2009

Recommendations of the Ripoll Inquiry—implications for product issuers |  ASIC’s further reforms for unlisted, unrated debenture issuers | Employment law news | The One.Tel decision—important directors’ duty update | Reform of directors’ liability provisions | ASIC news and corporations law update

Recommendations of the Ripoll Inquiry—implications for product issuers

Report released

In late November 2009, the Parliamentary Joint Committee on Corporations and Financial Services (PJC) released its report on its inquiry into financial products and services in Australia (Ripoll Inquiry).

The recommendations of the Ripoll Inquiry were not unexpected. The recommendations which are likely to have the greatest impact on product manufacturers and the funds management industry in general are set out below.

Commission-based remuneration

The PJC recommended the Corporations Act 2001 (Act) be amended to explicitly include a fiduciary obligation on financial advisers to place their client’s interests ahead of their own.

The report stated the PJC draws no conclusion about whether such a duty would automatically preclude the payment of commissions to financial advisers. However, in its submissions to the PJC, the Australian Securities and Investments Commission (ASIC) took the view the imposition of this legislative fiduciary duty would likely change remuneration practices, without the need for a concomitant legislative ban on commissions. Certainly, the PJC stopped short of recommending that all remuneration commission be banned but it did recommend the government consult with and support industry in developing the most appropriate mechanism by which to cease payments from financial product manufacturers to financial advisers.

Risk ratings

The PJC rejected the proposal that financial products should be given a “risk rating” by ASIC or any other government-authorised entity. The PJC is of the view it is inappropriate for ASIC to be assessing and labelling the risk of financial products, and in any event, it would be an unnecessary strain on its resources.

Product limitation

The PJC rejected the proposal that certain products should not be available to retail investors. The PJC said it was of the opinion it was not for parliament or the government to determine for whom particular investment products are appropriate. They said this is a decision for individual investors, in consultation with their financial advisers, who would be bound by a legislative fiduciary duty to put their client’s interests ahead of their own.

Separate licence categories

The PJC did not support the idea financial advisers should be categorised as product salesmen if they receive payments from product manufacturers and as “independent” if they are free from such conflicts of interest.

The reason the PJC did not support this view is that it would create an added layer of complexity to the licensing system and would require an extensive public education campaign and possibly add to further confusion about the roles of financial advisers.

It was clearly the view of the PJC that the other recommendations contained in its report would achieve additional professionalism and transparency in the financial planning industry and that achieving this would be more effective than the proposal to categorise financial advisers as salesmen or as “independent”.

More power to ASIC

The PJC also recommended ASIC be given more powers to ban individuals from the financial services industry and to take further action against licensees by suspending or revoking their Australian financial services licences.

Conclusion

Although the PJC did not recommend a legislative ban on commission-based remuneration, it is clear from the recommendations that the PJC agrees with ASIC’s view the introduction of a statutory fiduciary obligation on financial advisers to act in the best interests of their clients is likely to lead to a reduction in conflicts of interest, including the movement away from commission-based remuneration practices.

We eagerly await the government’s response to the report.

If you would like more information, then please contact Chris Mee by email or on 07 3239 2957.

ASIC’s further reforms for unlisted, unrated debenture issuers

New report released

The Australian Securities and Investments Commission (ASIC) has released its second report on the unlisted, unrated debenture market and a consultation paper which proposes yet further amendments to the disclosure regime for debenture issuers. The proposed reforms are part of ASIC’s “3-point plan”, a component of ASIC’s current industry-wide focus on retail investors and reforms to increase investor education.

“If not, why not” disclosure

The report issued by ASIC stated the “if not, why not” disclosure regime it has recently implemented was generally effective but could be enhanced to respond to recent market conditions. In the report, ASIC analysed the business models and disclosure of 15 issuers placed into external administration during the review period of 18 months against its benchmarks and by comparison with other issuers.

Further disclosure

Largely as a result of the analysis of what went wrong with the issuers now under administration, ASIC has proposed the following amendments to the existing benchmark disclosure regime for debenture issuers:

1. Changes to the equity requirements to exclude any amounts owing to related parties or associates of an issuer.
    
2. Changes to the liquidity benchmark, to address ASIC’s concerns about the liquidity of funds which have failed recently, including portfolio modelling to “stress test” cashflow estimates and disclosure of portfolio maturity profile details.
    
3. Removal of the requirement to obtain a credit rating from a recognised credit rating agency. Not surprisingly, ASIC’s review showed only one issuer of the 63 issuers reviewed had a credit rating.
    
4. Inclusion of a requirement to disclose interest rates payable under loans made by debenture issuers compared to interest rates offered to investors. ASIC did not provide an explanation as to why it considers such disclosure is necessary.
    
5. Further investor disclosure through inclusion of substantial information contained in ASIC’s investor guide, Investing in debentures?, in offer documents.
    
6. Discontinuation of ASIC’s interim no-action position about when issuers can describe their products as “debentures”. If this proposal is implemented, then many issuers will be required to refer to their products as “unsecured notes” or “unsecured deposit notes” rather than debentures.

Consequences for product issuers

It is likely that ASIC will implement its proposals next year, forcing further and more detailed disclosure from debenture issuers. We would also expect that ASIC will make similar announcements regarding their recent policies on further disclosure by unlisted mortgage funds and unlisted property funds.

Submissions on CP 123 closed on 4 December 2009 and a copy of our submission to ASIC can be accessed here.

If you require any assistance preparing your business to adopt the new updated benchmarks, then please let us know.

If you would like more information, then please contact Sarah McDonald by email or on 07 3239 2957.

Employment law news Did you know … From 1 January 2010, the balance of the new Fair Work Act 2009 (Cth) (the Act) will come into force. The bulk of the Act came into force on 1 July 2009. However, introduction of the expanded list of minimum statutory employment conditions, known as the National Employment Standards, and modernisation of the award system was deferred until 1 January 2010. Also from 1 January 2010, the Queensland and New South Wales Parliaments' referral of their powers to the federal government, relating to industrial relations for the private sector, will take effect with the result that sole trader and partnership employers in those States will now be governed by the Act. Previously, the federal government's power to legislate was limited to national system employers (largely companies incorporated under the Corporations Act 2001 and all employers in NT and ACT) which meant that important provisions of the Act did not apply to most private sector employers such a sole traders and partnerships. All States except Western Australia (who has refused) have now passed legislation referring their powers to the federal government. Contact If you would like some advice as to how the Act will affect your business, or assistance in updating your procedures, then please contact Kristy Dorney, an associate in our litigation and risk management team. Kristy Dorney can be contacted by email or on 07 3239 2960.

The One.Tel decision—important directors’ duty update

ASIC fails to prove its case

Justice Austin in the New South Wales Supreme Court handed down judgement on 18 November 2009 in the case brought by the Australian Securities and Investments Commission (ASIC) against Jodee Rich and Mark Silbermann. The action was commenced in December 2001, shortly after the collapse of One.Tel. ASIC’s case was that Mr Rich and Mr Silbermann misled the One.Tel board (which included James Packer and Lachlan Murdoch) about the financial state of the company.

Whilst One.Tel was a listed entity, its major shareholders were Kerry Packer’s Publishing & Broadcasting Limited and Rupert Murdoch’s News Corporation. Both of those entities lost huge sums in the One.Tel collapse. The question which Justice Austin had to determine was whether or not the executive directors had failed to keep the board informed of the company’s financial position. He did not have to determine whether or not the other directors on the board were careless in failing to find out the truth about their company’s position, although that issue might arise in other litigation currently on foot.

Waste of time?

Some commentators have pointed out that the case is a lesson for ASIC in how not to run litigation. The case ran for eight years and is reported to have cost ASIC $20 million in legal fees. If ASIC is ordered to pay the costs of the defendants, then the case could cost ASIC up to $40 million in total. This is particularly significant when considered in light of ASIC’s overall annual budget of about $300 million. There is no doubt that the case has chewed up an enormous amount of resources and diverted attention away from other routine compliance and enforcement activities.

However, the case will be of great interest to anyone involved in the management of companies. Justice Austin is an acknowledged authority on directors’ duties, and he has written his judgement in a way which will be of assistance to a wide audience outside of the One.Tel mishap. The judgement is 3,105 pages long but is conveniently broken up into chapters. Anyone wanting to focus on the important findings regarding directors’ duties should read chapter 23 which starts at page 2,942.

We have summarised some of the findings from the case, but for a more comprehensive coverage of the case, please go to our full length article here.

Directors should take note that this represents the current state of the law in Australia and their performance will be judged against these principles.

Duty of care and diligence

1. Justice Austin noted that the Corporations Act 2001 (the Act) did not intend to dampen business enterprise and penalise legitimate but unsuccessful entrepreneurial activities. Accordingly, the question whether a director had exercised a reasonable degree of care and diligence for the purposes of the Act could only be answered by balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question.
    
2. In assessing what a reasonable person would do in the position of the director in response to a given risk, the court needs to consider the magnitude of the risk and the degree of the probability of its occurrence, along with the expense, difficulty and inconvenience of taking alleviating action and any other conflicting responsibilities the director may have. In considering the cost of alleviating action, Justice Austin accepted a submission put to him by Mr Rich and Mr Silbermann that the court should avoid a finding that certain information not contained in board papers should have been there where the consequences may be that board papers would grow to the size of a telephone book.
    
3. The statutory standard of care and diligence for company directors recognises the distinction between negligence and mere mistakes. In particular in the One.Tel case, the complaints made by ASIC were about financial forecasting. Justice Austin noted that forecasting is a difficult and uncertain process, with much room for mistakes and errors of judgement, and for differences of opinion. The directors could not be liable just because they made mistakes in the processing of financial forecasting or because they formed a different opinion to ASIC or the court.

Business judgement rule

1. In considering what constitutes a business judgement, Justice Austin approved U.S. commentary to the effect that it doesn’t just encompass risky or economic decisions, but also applies to decisions relating to corporate personnel, the termination of litigation and other less explicit business decisions. It could embrace decisions including the setting of policy goals and the apportionment of responsibilities between the board and senior management. Justice Austin also considered that it would include matters of planning, budgeting and forecasting.
    
2. However, he noted that under the Act, it must involve “a decision to take or not take action”. This means that a decision must consciously be made so that the judgement has actually been exercised. A director who simply neglected to deal with proper safeguards, with no evidence that he or she even turned his or her mind to a judgement of what safeguards there should be, has not made a business judgement and accordingly, cannot invoke the defence.
    
3. In One.Tel, ASIC claimed that Mr Rich and Mr Silbermann had artificially attempted to treat what was, in substance, inaction or omissions on their part as conscious and considered acts involving the exercise of judgement. Justice Austin did not accept that submission. He accepted evidence from Mr Rich and Mr Silbermann that they made decisions about the matters of which ASIC complained. It was not a case where the directors had failed to turn their minds to decisions that ASIC alleges they should have taken. The directors considered the matters of which ASIC complained, but made decisions with which ASIC disagreed. In essence, this is why ASIC’s action failed.

Conclusion

The reasoning and conclusions in this case are compelling reading for anyone involved in the management of a company. Justice Austin has articulated the principles relevant to assessing the performance of a director in a way that should be readily understandable to company directors and officers.

McMahon Clarke Legal can assist you with any queries regarding directors’ liability and obligations.

If you would like more information, then please contact Sarah Davies by email or on 07 3239 2960.

Reform of directors’ liability provisions

Legislation audit

On 6 November 2009, the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, announced the agreement reached at the Ministerial Council for Corporations (MINCO) meeting in Sydney on the next step in reform of directors’ liability provisions.

The Commonwealth, States and Territories will begin to audit their legislative provisions dealing with directors’ liability against a set of principles that MINCO has agreed to.

Once the audit is completed, there will be a move to amend any laws that do not adhere to the agreed principles. This will include a harmonisation of some key concepts used in the legislation. The objective is to achieve consistency across Australia on the laws that impose personal liability on directors.

Principles recommended by MINCO

MINCO has agreed to the following principles for adoption on a national basis in relation to corporate liability and the circumstances in which directors may also be liable for corporate fault:

1. Where a corporation contravenes a statutory requirement, the corporation should be held liable in the first instance.
    
2. Directors should not be liable for corporate fault as a matter of course or by blanket imposition of liability across an entire Act.
    
3. A “designated officer” approach to liability is not suitable for general application.
    
4. The imposition of personal criminal liability on a director for the misconduct of a corporation should be confined to situations where—
   
   
   1. there are compelling public policy reasons for doing so (e.g., in terms of the potential for significant public harm that might be caused by the particular corporate offending)
       
   2. liability of the corporation is not likely on its own to sufficiently promote compliance, and
       
   3. it is reasonable in all the circumstances for the director to be liable having regard to factors including—
      
      
      1. the obligation on the corporation, and in turn the director, is clear
          
      2. the director has the capacity to influence the conduct of the corporation in relation to the offending, and
          
      3. there are steps that a reasonable director might take to ensure a corporation’s compliance with the legislative obligation.
          
5. Where principle 4 is satisfied and directors’ liability is appropriate, directors could be liable where they—
   
   
   1. have encouraged or assisted in the commission of the offence, or
       
   2. have been negligent or reckless in relation to the corporation’s offending.
       
6. In addition, in some instances, it may be appropriate to put directors to proof that they have taken reasonable steps to prevent the corporation’s offending if they are not to be personally liable.  

Commentary

Some commentators have remarked that the principles have not gone far enough. The agreement reached by MINCO is as a result of a report prepared by the Corporations and Markets Advisory Committee (Committee) for the previous Federal Government in 2006. In that report, the Committee indicated its concern that some legislation treated directors as being personally liable for the misconduct of their companies unless they can prove their innocence. This is a departure from a principle which is a cornerstone of our legal system; that a person is innocent until proven guilty.

Whilst some of the principles referred to above are a step in the right direction, it remains to be seen whether or not the reform of this area of law will continue. To a large degree, this will depend on continuing cooperation between the States and the Commonwealth to ensure that appropriate legislative amendments are made.

We will continue to provide you with updates about this important issue.

If you would like more information, then please contact Kristy Dorney by email or on 07 3239 2960.

ASIC news and corporations law update

Funded class action

The Australian Securities & Investments Commission (ASIC) has responded to the Federal Court decision in Brookfield Multiplex Limited v International Litigation Funding Partners PTE Limited by granting interim relief from the requirement for litigation funders to register their class actions as managed investment schemes. In the Multiplex decision, the Federal Court held a funded class action against Multiplex was a managed investment scheme under the Corporations Act 2001 (Act) and so must be registered with ASIC.

The relief will generally be granted, on individual application, to lawyers and litigation funds involved in the conduct of class actions which were commenced before 4 December 2009. It will apply until 30 June 2010.

Online financial services disclosure

ASIC has issued a consultation paper seeking further feedback on how to better facilitate the delivery of financial services information online. Consultation Paper 121—Facilitating online financial services disclosure (CP 121) is in furtherance of the consultation paper released in April 2009 (Consultation Paper 93—Facilitating online financial services disclosure (CP 93)).

ASIC sought comment on the following matters:

1. ASIC’s proposal to give relief to allow issuers to provide product disclosure statements, financial services guides and statements of advice to retail clients via hyperlinks and references to website addresses without first having to obtain client nomination or agreement, as long as retail clients can elect to receive hard copies.
    
2. Whether paper disclosure or online disclosure should be the default method for delivering financial services disclosure. ASIC noted as a result of the current law, issuers are generally required to provide paper disclosures to retail clients unless the retail client has actively decided to receive financial services disclosure online. As such, ASIC notes paper has been the default disclosure mechanism for retail clients.
    
3. ASIC’s amendments to the good practice guidance in relation to online disclosure as a result of comments received on CP 93.

The date for submissions to ASIC closed on 11 December 2009.

Dividend payments

The Corporations Amendment (Corporate Reporting Reform) Bill 2010 (Bill) was released as an exposure draft on 4 December 2009.

One of the key reforms is to the test in section 254T of the Corporations Act 2001 (Act) which provides a dividend may only be paid out of company profits. The Bill proposes the “profits test” will be repealed and replaced with a more flexible requirement which allows a company to pay dividends if—

1. the company’s assets exceed its liabilities and the excess is sufficient for the payment of a dividend
    
2. it is fair and reasonable to the company’s shareholders as a whole, and
    
3. it does not materially prejudice the company’s ability to pay its creditors.

The existing duty to prevent insolvent trading will continue to apply. If passed, then the reforms proposed by the Bill may have a significant impact on the attractiveness of the corporate structure as a business and investment vehicle.

The closing date for submissions to Treasury is 3 February 2010. We will keep you informed of progress of the Bill.

If you would like more information, then please contact Sarah McDonald by email or on 07 3239 2957.

McMahon Clarke Legal specialises in legal services associated with funds management, capital raising and litigation and risk management for listed and unlisted entities. For a full list of our services, please visit the main part of our website at www.mcmahonclarke.com or email us at info@mcmahonclarke.com.

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