CHAIR —I declare open this Joint Statutory Committee on Corporations and Securities hearing and welcome the witnesses who will be appearing before the committee this evening. The purpose of the hearing is to take evidence on the committee's inquiry into aspects of the regulation of proprietary companies. This is the first hearing on this particular inquiry and the committee will be holding a further public hearing in Melbourne on Friday, 30 June 2000. The committee has received and published 13 written submissions, which it will consider along with the evidence it receives during its public hearings in preparing its report.

The committee prefers to conduct its hearings in public. However, if there are any matters that a witness wishes to discuss with the committee in camera, we will consider such a request. I would also like to remind witnesses that the giving of false or misleading evidence may constitute a contempt of the parliament. This hearing will be held while the parliament is sitting, so some committee members may have to leave the hearing from time to time to attend divisions in either chamber. I hope this will not unduly disrupt the proceedings. Before we proceed with the hearing, I will just indicate that I have to attend another meeting for a brief period. Once we start I will hand over the chair to Senator Gibson. I welcome the representatives of the Australian Institute of Company Directors. Do you wish to make an opening presentation to the committee?

Mr Elliott —Yes, we do.

CHAIR —I will ask you to proceed with that and then there may be questions from the committee.

Mr Elliott —Before I start, let me say by way of background that Mr Grant is an experienced company director. He is also an ex-partner of KPMG, a long time commentator on financial reporting, currently managing director of the Australian annual report awards, and probably most importantly, other than being a member of the AICD's accounting committee, is immediate past National Director of Accounting Policy for the Australian Securities Commission, as it then was.

Mr James Service Snr is well known to the committee, being an extremely well-known director of both large public and small proprietary companies, and also an extremely active member of the AICD in an honorary capacity, having been a former member of our national council.

For those who are not aware, the Institute of Company Directors is an organisation with over 15,000 directors as members and, I think most importantly for this committee, well over 13,000 of our members are directors of proprietary limited companies in all states, all industries and all sizes of proprietary companies. I will make a few very short points as an overview and then hand over to Stuart Grant who will make a slightly more technical presentation, and then we would be very pleased to take questions and enter into any discussion.

Generally, the institute wishes to see increased business efficiency, reduced costs and red tape, and appropriate levels of accountability through, and I stress, meaningful disclosure. The AICD has been a very long term contributor to the issues that are before this particular committee. I point not only to the submission that you have before you dated 17 April this year, but also to three prior submissions which, if you do not have, we can forward to you, they being August 1994, October 1994 and February 1995. I can give the secretary particular references to paragraphs within those submissions which are directly on point. The AICD welcomes this review having called for it in our October 1994 submission, and thanks to the PJC for the opportunity to appear here today. In addition, we have made a written submission.

Before I hand over to Stuart Grant for a more detailed presentation can I leave you with one particular overarching message that the AICD has, and that is that we really do not want to see small business in Australia, which is after all the engine room of the economy, impeded by unnecessary red tape from growing and thus employing more people. With that I will hand over to Stuart Grant.

Mr Grant —You have before you the submission from the Australian Institute of Company Directors. I am pleased to say it is probably one of the shortest submissions, which we try to achieve, and the key features of that are fairly simple as well in that. We say that with the present requirements which were enacted in 1995 there have been some favourable impacts but some adverse impacts as well, and obviously it is the adverse that we are focused on. The particular concerns arise from the impact upon large proprietary companies of the changed requirements that arose in 1995. In particular, if you are so-called `large,' those companies now have to lodge and have audited their financial reports, and some small companies as well are caught under those requirements if they are foreign controlled.

It is probably that area that is the main issue of concern to the AICD because previously, typically, those companies, and there are about 2,000 of them, were classified under the old rules as exempt proprietary companies and did not have to lodge financial reports or have an audit. So for them the changes have been quite dramatic. Certainly, we have had representations, strongly, that it is an unreasonable invasion of privacy for those family companies.

To summarise, the key concerns regarding the present requirements for preparation, lodgement and audit for propriety companies are as follows: that the requirements are somewhat complex, and that they are arbitrary in that you can flip-flop in and out, being large or small depending on if you sell a property or whatever in one year—you pop over the $10 million revenue limit one year, but the next year you do not. It is uneven in impact in that there are a lot of organisations that do not have to file, even though they are large, because they are so-called grandfathered, and you have quite a cottage industry out there advising propriety companies on how to structure their affairs so they sidestep the requirements through setting up trusts or limited partnerships.

It is considered that the present requirements are unfair on those large proprietary companies in that they require public lodgment of their affairs when it is not considered that there is really a public benefit in so doing. There are increased costs for those companies and, in summary, as I have mentioned, increased requirements at large for that 2,300-odd group. There is also an element of unfairness in that there is no mechanism, as ASIC have acknowledged, to identify those large proprietary companies that have kept quiet and not lodged. Through the application of the reporting entity concept there are concerns that the results are somewhat haphazard and ineffective in that the present wording of that definition means that it is largely a discretion as to whether or not a company deems itself to be a reporting entity. The definition is so subjective in that it says if you can identify so-called `users dependent', then you are a reporting entity. But `users dependent' is a highly judgmental description, and you can really argue it either way.

It is not in the interest of small or, particularly, medium sized businesses to have to lodge, because of the intrusion on privacy for no particular public benefit and because of the cost involved. We have suggested in our submission that the audit requirements flow from the lodgment requirements. Our submission has indicated that we would recommend a reversion to the exempt proprietary company definition, or something similar, which would enable particularly companies that are clearly family owned and controlled—with say, fewer than 20 shareholders—to be not required to lodge and not required to have an audit. Of course, the extent to which they prepare their financial statements is largely up to them—which is fair enough, because they are family companies. We are suggesting that that be the appropriate differentiation between the public disclosing entity type companies that have got comprehensive requirements and the family company, where we are suggesting there is not really a public interest requirement. In summary, those are the key messages that we would like to pass to you.

ACTING CHAIR (Senator Gibson) —What specific criteria would you be recommending to us then for the exempt proprietary company to qualify?

Mr Grant —It is really picking up the definition that was previously in the law. Hopefully, it can be simplified, because in fact it was somewhat convoluted. But the substance of it would be that existing definition. Ironically, although the definition of exempt proprietary company is not in the Corporations Law today, it is still required. I do not want to get too technical, but if a large company is to continue to be grandfathered, as it is called, which means they do not have to lodge, then they have to continue to be an exempt proprietary company under the old definition. So it sort of lingers in the background still, even though it is not in the law. We might as a further refinement of that suggest, say, 20 people—family members or associated persons—as being a cut-off limit for that definition.

ACTING CHAIR —What about other entities?

Mr Grant —There is a tiered approach under the old definition and it gets very technical. I think you go about four layers and if you get to an individual person after four layers then you tick it off; you are right; but if you go to a fifth layer, you are not. That is very arbitrary. I would hope that it could be simplified. But from our point of view we would recommend that the principle be adopted, and obviously there would be some work to be done on refining a precise definition. We do not have a precise definition at this stage.

Mr Service —We have been discussing this issue, because the institute is very committed to transparency in those organisations which have a general responsibility to the public; that is, those who raise capital, borrowings or deal with the public on a large scale where there is a wide interest in their solvency. One of the things we believe ought to happen, particularly if the committee is of a mind to get rid of the present large/small definition, is that every company should have to have all its directors sign and lodge with its annual return a declaration of solvency. We think that that, amongst other things that are of public importance, will actually make directors really think about this solvency issue. We are all seeing situations in the courts where directors simply have not addressed their minds to whether or not their companies are solvent. Whilst as shareholders they may suffer, very often a lot of other people suffer as well.

I think it is fair to say the institute would not even be uncomfortable if you were to recommend that proposal and that part of it ought to be that, when a company has signed its declaration of solvency, it should have an obligation to give a copy of that declaration to every one of its employees. They are one of the groups of people that need protection and, I have to say, are not adequately protected in fact by the law at the moment. The average employee does not go to ASIC and say, `Can I look at this company's accounts?' Employees ought to know that their employer is solvent. We think, in terms of public policy, that would be quite effective in really making directors think about what their responsibilities are. They already have those responsibilities but, clearly, some of them do not address them.

Mr Grant —I would add the comment that one of the changes in the simplification law that came down in 1995 was that the so-called small companies no longer have to prepare a formal financial report. In fact, at the time the Institute of Company Directors queried that and really raised its eyebrows to say, `Is that really desirable?' We would like to re-raise that and suggest that in fact we wonder why that was introduced, because we see it as a very important discipline that every company be required to present—to prepare for itself and for whoever else within the shareholding group needs it—a formal financial report.

The comprehensive requirements of accounting standards come in two parts, being the measurement requirements—how you measure your assets, how you measure your liabilities, if you recognise finance leases as borrowings, which the standards require; so there is that component—and the second component is disclosure, and typically you see `note 43 to the accounts'; you see lots of notes. Instead of being required to follow them, the differentiation is that, instead of those, we are suggesting that many of those notes may not be required to add to the disclosure but that the basic computation measurement requirements should apply, we are advocating, to all companies. That is not the case at the moment. There is a proposal there from ASIC, as you have probably seen. It is a draft released by ASIC that would invoke that. But that is, more or less, a little bit of regulation, as we see it, by the regulator instead of the parliament. So we would get to the same result as they are suggesting but perhaps through a different mechanism.

ACTING CHAIR —If I remember correctly, the thrust of the previous changes in the law were to try to help small companies, to make life easier for them and to get rid of some red tape. Are you now of the view that, on reflection, it would be better if everybody had to report?

Mr Grant —To prepare, not to report.

ACTING CHAIR —Sorry, to prepare—okay.

Mr Grant —To prepare; there is a big difference. It would be not published, not lodged, but it would be prepared and be required to be submitted to all shareholders.

Mr Service —The purpose of that is not simply to keep the shareholders informed, it is to try to encourage good management of Australian companies. In my view, even the smallest company ought to have some kind of accounts; otherwise, how does it manage its business? If management is bad, in the end the national interest suffers.

Mr Grant —It is like a periodic school card.

ACTING CHAIR —Your suggestion about certifying the solvency complements that?

Mr Service —That helps to protect the public interest, including people like the employees. If I go to somebody and say, `I want to open an account to buy my stationery,' at the moment most of those suppliers actually do nothing about credit. If they like the colour of my eyes they give me an account—which is not very wise, but that is what they do—or they ask for directors' guarantees—that is very common. In small companies, I personally do not object to that. If we go down this solvency declaration thing, all you have to say to somebody who wants to open an account with you for ordinary trading is, `Give me a copy of your declaration of solvency.' A lot of consequences will flow from that in the sense that, if the declaration is fraudulent, the creditor is likely to have personal recourse to the directors, so directors are going to take this very seriously, and we think that is highly desirable.

Mr Elliott —This process will, in effect, focus the minds of the directors on their current obligations for solvency, but it will not—getting back to your point of the red tape—add to the burdens and the costs of unnecessary extra regulation and red tape. It will achieve the ends whilst leaving the small business people free to get on with doing the business and remaining relatively competitive.

ACTING CHAIR —Do you want to make any further comments?

Mr Elliott —I can provide the secretariat of the committee with the exact paragraph numbers within our previous submissions which address some of the points and flesh them out a little rather than verbatim read from previous submissions—that is a pointless exercise. A number of these issues relate to creditors making their own inquiries, red tape and other ways of achieving this. A final point is that the importance here is the difference between preparing the financial documents and the disclosure and therefore auditing of them in a public or wider sense. That is a substantial difference and we do that on the basis of what we believe is meaningful disclosure—disclosure where it is going to be meaningful to people who have no other way of ensuring the soundness financially of the organisation they are dealing with as employees or creditors.

Mr Service —In that case we are fully supportive of disclosure. That must be very much understood—we are not here just to say directors are wonderful people and should not have any laws to obey; that is not the position of the institute.

Senator COONEY —Though they are.

Mr Service —Senator, thank you for that; it is the nicest thing that has been said to me in at least a week.

Mr Grant —The principle in the definition of exempt proprietary company was in place for many years and seemed to work well. I am not aware, in my professional environment, of any grounds for concern with it, so it remains curious to us as to why it was changed.

Mr Service —It might almost have been one of those accidents that happen.

ACTING CHAIR —I was involved at the time but I cannot remember the reason behind it.

Mr Grant —The other comment I would make is probably self-evident, but I will put it in another way: clearly, all the commentators and people making submissions—I suspect you as a committee, too—agree with the principle that there should be some sort of differential reporting between the big end of town, the listed companies, and the small end. Differentiation of reporting requirements and content is almost unanimously accepted. The debate is where to draw the line, and that is really what we are discussing, I suppose.

ACTING CHAIR —Senator Cooney, we have virtually finished. Did you want to ask any questions?

Senator COONEY —I can understand what you are saying about what is reasonable but, in the old days, I did some industrial accident work and what have you to earn a few shillings for the table, and what is reasonable in any particular circumstance can be a problem. Have you thought of that? Can you really define what the break is? The various tests are really arbitrary in the sense that you could say, `It is going to be $2 million or $5 million.' Can you think of any way that could be improved upon? I suppose it cannot be, unless you go to the court the whole time, but have you thought of any test other than simply having an arbitrary figure beyond which you report and below which you do not?

Mr Grant —As we were saying, we are suggesting that there not be an arithmetic cut-off but a family type cut-off. In other words, if it is clearly family controlled and owned, then that should be the distinction.

Senator COONEY —What the system is doing, in any case, is picking distinguishing marks which in a certain sense are arbitrary. Can you think of any way of doing it that would not be arbitrary? The family way of doing it is arbitrary; an amount of money is arbitrary.

Mr Grant —I believe you can come up with a definition. There was one under the exempt proprietary company definition that used to apply that was capable of rational and objective implementation.

Senator COONEY —Yes, but I suppose people could say, `Well, who is going to make the judgment?'

Mr Service —I think there is an additional concept to that though, Senator, and that is that you cannot qualify what we are describing as an exempt proprietary company if you want to raise capital or borrowings from the public. If you want to do that you have got to be transparent and you have got to tell the world what your situation is because otherwise you do not protect the public. The sorts of companies that fitted under the old definition of exempt proprietary companies were not permitted to do that—unless they were badly managed, which is not in the national interest—but they were not destroying the public interest and therefore the public interest has no particular interest in whether they are very profitable or not very profitable or how they are performing.

The other thing we suggested—I think before you came in—is that the institute would be very supportive of every company, and I mean every company, having to lodge annually a declaration of solvency to make the directors really address their minds to the fact that their business is in good shape. We have also suggested that every employee of those companies should be required to be given a copy of the declaration of solvency on the basis that the average employee is not going to go to ASIC and look up the records. Of course, they are not but they ought to know that the boss is actually going to be able to pay their wages. The institute has a very strong view about that.

Senator COONEY —I am sorry I came in late. I had to be in the chamber.

Mr Service —We understand.

Senator COONEY —It seems to me that we have got to have some sort of test and that is going to be an arbitrary test. I suppose what you are saying is that—and I can understand this—any tests are going to be arbitrary to a certain extent, but the ones we suggest are less arbitrary than the others. That is closer to getting to the answer than the others.

Mr Service —And the old system, by and large I think, worked very well, whereas the new one is causing quite a lot of people a lot of pain. There has been no demonstrable public benefit from that. I think that is an issue. There has been nothing come out of it that has been of value to the public at large.

ACTING CHAIR —If there are no further questions, I thank you very much for going to the trouble of coming and meeting with us tonight. Thank you for your submission. It is very useful.

[5.33 p.m.]