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April 26th, 2011

Centro case tests duty of directors

Hervey Bay has a Centro shopping centre

Leonie Wood
April 26, 2011

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IT IS, perhaps, the most elementary aspect of financial analysis. Faced with a company balance sheet, the line item examined before all others is current liabilities: short-term debt, or what must be paid in the next year.

So it is a little difficult to understand how Centro directors in September 2007, applying their full faculties, overlooked this line when examining the property group’s final accounts.

The blunder became apparent later in 2007 when Centro faced a catastrophic loss of investor confidence after being forced to reveal it was struggling to refinance its loans. Eight Centro directors and officers are now defending allegations by the corporate regulator that they were negligent.

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That the directors did overlook the item is not in dispute in the Federal Court. What is disputed is the extent to which directors are required to probe the company’s accounts or go behind what management and auditors tell them.

Justice John Middleton is being asked to consider if Centro directors were plainly negligent in their duties, as the Australian Securities and Investments Commission contends, or whether this case represents a reaching up by the corporate regulator for some ever-higher and impossibly perfect standard of care by directors, as the Centro directors claim.

Lawyers for Centro directors suggested that to raise issues already checked by management and auditors meant board members risked being ”laughed at effectively for making the blunder that a first-year accounting student wouldn’t”.

But ASIC argues the issue is not a difficult one. It’s fair to note that the spectre of Blind Freddy – he who would see the glaring error or obvious mistake, even if blind – has been raised many times.

What Centro directors missed was billions of dollars of debt. About $1.1 billion of loans, wrongly classified as long-term debt in the August preliminary accounts, surfaced as current liabilities in the September final accounts but directors apparently didn’t notice it.

It was several months before the errors of incorrect classifications were fully analysed at Centro, leading the group to discover another $2 billion of short-term debt and $US1.7 billion of guarantees, which had been approved after balance date and should have featured in a note to the accounts. What the non-executive directors and former chief executive Andrew Scott want the court to accept is that the board took reasonable steps to carry out its duties as best it could by putting in place processes designed to ensure that errors were not made.

They point out that Centro employed teams of accountants and finance staff, and it commissioned external auditors from PricewaterhouseCoopers to examine the accounts.

It had a fully functioning audit committee, headed by non-executive Sam Kavourakis, and it did page-turn examinationsof financial statements and accounts.

The internal accountants and the auditors wrongly classified the debt and

failed to alert the board.

So to ASIC’s claim that the directors were negligent, the directors say: ”What more could be done?”

Indeed, counsel for the non-executive directors, Alan Archibald, QC, launched into full hyperbolic flight on this, claiming ASIC was seeking to impose an ”intolerable burden” on directors because, as he fashioned it, ”every single line, almost every single word and every single number has to be scrutinised by each director separately”.

”Boardrooms of Australia will empty overnight if this is the tenor and the rigour of the obligation to be imposed on them,” Mr Archibald argued. ”Nobody would expose themselves to those responsibilities.”

As Justice Middleton replied: ”That is the balance the court has to reach, isn’t it?”

What more could be done? ASIC contends there is a simple answer to that. The directors should have brought their own experience, their own curiosity, the cumulative wealth of their individual experiences to bear on the accounts, and – importantly – they should be looking for obvious mistakes. The kind that ”Blind Freddy” would see.

In other words, putting in place ”processes” is not enough. The directors should not leave themselves to be bare automatons, duly nodding when management presents them with accounts and then blithely signing the accounts because management and auditors say the statements are in order. They must engage their minds to carry out their individual fiduciary responsibilities.

ASIC’s argument, however, is not that directors must have a detailed understanding of every accounting standard.

The regulator instead is saying that directors should have a general knowledge of certain fundamental aspects of accounting and they should be asking questions that focus on those issues.

And in this particular case, the Centro directors had been informed via board packs about the short-term debt and the necessity to refinance. Leslie Glick, SC, for Mr Scott suggested that when the judge was weighing up whether Blind Freddy would have tripped across the debt, the fact that Centro’s auditors, its internal accountants and the chief financial officer also overlooked it ”has to go into the mix”.

ASIC would say that doesn’t matter. The regulator contends the Centro directors ”had to bring the knowledge that they had acquired over the period of their directorships and the material that they had been given in the process of reviewing”.

When the case resumes on May 2, all the directors will be called to give evidence and each one can be sure there will be much scrutiny of what he did in September 2007.

Sourced & published by Henry Sapiecha

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