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Doctoring the corporate malaise

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PETER COSTELLO, MP Shadow Attorney General Shadow Minister for Justice

Address at Corporate Self-Regulation Conference, Boulevard Hotel, Sydney

22 June 1992


I am invited today to speak on "Doctoring the Corporate Malaise". The first step in doctoring any malaise is diagnosis. Diagnosis involves identifying symptoms and causes. Once these have been identified appropriate treatment can be prescribed.

The chief illness afflicting corporate Australia in the last five years has been misconduct. Some good treatment has been administered and further medication is required, but this is not the only cause of malaise in corporate Australia today. Our doctoring needs to be focussed now on other problems as well.

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In the lead up to the stock market crash of 1987 and in its aftermath, the affairs of a number of large companies were conducted in a reprehensible way. In these companies directors were prepared to abuse positions of trust and put their personal interests ahead of shareholders. Many practices which occurred whilst share prices

were rising were exposed when share prices fell and the examination of company affairs revealed that assets had disappeared out of the public company for the personal benefit of those managing them. ,

' Corporate regulation proved an inadequate restraint on such practices and failed to protect shareholders and creditors.

By and large the companies which suffered did not have directors who were independent and of sufficient standing to challenge the officers concerned. Indeed, the company directors were frequently executive officers who managed the company's affairs and reported to themselves. In many cases the managers had significant proprietary interests as well.

In cases where there were independent directors prepared to observe their obligations to act honestly and in the interests of shareholders, they were a force for good. For example, the refusal of independent directors of Quintex to agree to enormous management fees finally brought full exposure of the affairs of that group.

I do not want to overlook the importance of internal restraints on corporate misconduct. An excellent paper on corporate practices and conduct was prepared by a working group of business organisations and published in 1991. It recommended that the boards of public companies include a majority of non-executive directors, that

audit committees with a majority of non-executive directors be set up and that they have unrestricted access to financial officers to allow an independent check on management.

Such recommendations are, if you like, recommendations for division of power and supervision of decision making. As in politics, division of power in companies acts as a brake on extreme action. The division of responsibilities also provides for different centres in a company to supervise each other and take preventative action against


In many cases, however, not only did internal restraints fail but external restraints failed as well. The external restraints are the restraints imposed by law or external suasion. When corporate regulators were able to intervene, they were able to have an ameliorating effect. One example was where the NCSC intervened in the Bond

Corporation and West Australian Government acquisition of interests in the Bell Group. Another was where the Australian Stock Exchange threatened to de-list the Bond Corporation for failure to supply financial information.

But the national regulator proved unable to restrain a good deal of misconduct. It was stretched beyond its capacity, it had less than full co-operation from the state regulatory agencies, responsibility for corporate regulation was diffused, and it was

under-funded. Some of the state agencies, for example in Western Australia, could have been worried they would not obtain full political support for their efforts.

There was a need to overcome these problems, and the establishment of the Australian Securities Commission - one national regulator, with adequate funding, was a major step in the right direction.

It is important to review these developments because I fear another view has developed in some quarters - the view that this corporate misconduct occurred because we did not have sufficient laws to deter it. This is the view that says we will not doctor this malaise until we have passed more laws, and expanded statutory

prescriptions on how to manage a corporation.

At first glance it is attractive to argue that if bad conduct has occurred we should pass more laws to stop it. It is now relatively easy to pass more laws. It is much harder to do the difficult work of enforcing them.

If the real problem was enforcement, as I maintain it was, it is no answer to keep adding to the statutes. That will put more laws in the statute book. But experience tells us that law in the statute book is not necessarily law in force in the boardroom. Our laws must be targeted, and when targeted, enforced.

A patient who fronts a doctor with a finger infection may be honestly told that the amputation of the arm will end it. The trouble with an amputation is it is not

targeted. The treatment is not commensurate with the illness, and takes away a lot of good with the bad.

Throughout the 1980's we had about three inches of corporate laws. I am not convinced that the result would have been vastly different if we had four inches. Now, of course, we do have four inches of laws, and the Government is proposing to expand it to five I

The additional inch of law to which I am referring is, of course, the Corporate Law Reform Bill of 1992 ("the Bill") which is scheduled for introduction into the House of Representatives in August.


The argument for further legislative change always starts from the proposition that Australia's international reputation is bad. The argument is that somehow we exceeded worst practice by such a quantum that we now need to exceed world regulatory practice by a similar quantum.

Our corporate misconduct was bad in the 1980's but we were not in a class of our own. In the English-speaking world we had company - bad company. In the United States, for example, there was Levine/Boesky/Milken episode; the Savings and Loans debacle which may cost $US500 billion in federal bail outs; the banking collapses where in Texas alone 349 commercial banks failed.

In the United Kingdom there was the Parnes/Lyons/RonsorV Saunders/Guinness affair, the Blue Arrow rights issue, and perhaps one of the biggest frauds of all time in the Mirror Newspaper Group.

One of the aspects that perhaps could set Australia apart in international bad practice is the extent to which politicians were associated with commercial failure and misconduct. We have Royal Commissions into financial affairs of state governments or their financial institutions in three states across southern Australia investigating this

at present.

W here we are now at risk of getting into a class of our own is in the volume of our statutory regulation which dwarfs that of the US, UK and New Zealand.

Nor do I accept the argument that the laws we did have were biased against a ' prosecution or weighted in favour of defendants. Now that charges are actually being brought and heard the conviction rate is quite high. What is more, the convictions are proceeding under the 1981 Code laws - Mr Bond has been convicted, Mr Skase is

facing charges.

I think one of the reasons that enforcement has been slow was the fear of failure. There was almost a fear to lay charges in case they were not proved. Now that a couple of convictions have been secured I think prosecutors and regulators will be confident and positive about getting on with the job.

A number of carefully-crafted explanations for the failure to enforce the law were developed in recent years, I accept one · namely the divided structure and under funding of the corporate regulator. I do not accept, as was said at the time, that the fault lay in the jury system or the standard of proof. At the time I took the view that

there was no reason to change historic criminal procedure. I believe that subsequent events have proven this correct.

The urgency now is simplification of corporations law. Simplification will promote voluntary compliance and legal enforcement. Enforcement (both voluntary and coercive) will not be aided by ever-expanding complicated prose directed at problems which have never been precisely defined. As a result, I welcome the announcement

by the Attorney General last Thursday that he will submit his proposals on related party transactions in the Bill for another redraft. I hope the difference between the


third draft and the second draft is much greater than the difference between the second and the first drafts. We were right to oppose both the first and second drafts.

I come now to the respective roles of enforcement agencies in doctoring this aspect of the corporate malaise. I am of the firm view that as far as possible the Corporations Law should separate civil and criminal contraventions. At the moment the same conduct may give rise to either civil or criminal proceedings and civil or criminal

consequences. For example, Section 232 on directors' duties and Section 592 on incurring debts without reasonable grounds to expect they will be paid leads to civil and criminal contravention.

Conduct which should be marked out for criminal consequences and treated separately in separate sections is conduct that has an element or dishonesty or an element of fraud, that is, a false representation made knowingly or without believing it true, or recklessly not caring whether it is true or false.

Conduct which is honestly negligent or involves innocent misrepresentation should be marked out for civil suit and civil penalties.

The appropriate penalties for conduct of a criminal nature are fines and

imprisonment, and in this context imprisonment is a particularly apposite penalty. Sentencing is, of course, a matter for the trial judge, but where large sums are involved, fines are not such a strong deterrent, nor do they register the obliquity which must be registered against the conduct.

The prosecution of criminal offences ought to become the primary responsibility of the Director of Public Prosecutions. Civil enforcement, particularly prevention and recovery work, should become the primary focus of the Australian Securities Commission. In due course we could move closer to the system as prevails in the

United States, where the Securities Exchange Commission handles civil law enforcement and the US Justice Department handles criminal enforcement.

The current ► «j i ·:· irate malaise

So far I have been concentrating on doctoring that aspect of the corporate malaise which took hold in Australia during the late '80's. It is now 1992, and corporate Australia is facing problems on a different front.

Gross domestic product has fallen since June 1990. New capital expenditure fell by about 2% to June '90, another 7% to June 1991 and looks like falling by about 15% or 16% to June 1992.

The malaise that affects corporate Australia today is recession.

I am not going to argue that this recession has a legal cause. This recession was brought on by government policy, particularly undue reliance on monetary policy and sustained high interest rates.



But the point is that there is another illness that afflicts corporate Australia today. It is low consumer confidence, recessed economic conditions, poor returns, and aversion to new investment.

The government's focus on corporations law is still legalistic. It is sometimes said that the General leading an army is always an expert on the last war - not the current one! Our past problems were corporate misconduct - our current ones are economic development.

The focus of corporations law must now become economic. We must now turn to tailoring a regulatory scheme to investment and economic development, Our Corporations Law will not be conducive to recovery, nor will it doctor the current malaise if it keeps imposing higher regulatory costs on corporations. We must aim to

get regulatory costs down. The more expansive, the more voluminous, the more complex the law, the higher the compliance cost, the higher the cost of lawyers' and accountants' fees for administering and explaining it, and the more uncertainty there is in taking commercial decisions.

The eradication of misconduct and creating a climate conducive to investment do meet. They meet at the point where we prevent dishonesty and fraud. Eliminating dishonesty and fraud from markets is conducive to investment. Where we go further and regulate non-fraudulent transactions in an attem pt to prescribe how commercial

decisions are to be made, regulation becomes a barrier to investment.

I am told anecdotally that company directors now ask the question: "Is my house safe?" as often as they ask whether a proposed investment will bring returns to the company, There is a good deal of asset alienation going on amongst company directors at the moment, because frequent changes to the law and the ever-expanding

scope of personal liability has brought on a defensive mentality. The defensive mentality looks to avoiding legal suits before it looks to creating opportunity.

In particular, there is a legitimate fear that what might look like a good commercial investment now, five years later in a court of law, in a changed business environment and with the wisdom of hindsight will look like a bad decision bringing on personal liability to the director.

This is why I have supported the introduction of the business judgment rule. The business judgment rule as recommended by the Companies and Securities Law Review Committee, Report No 10 in 1990 provides as follows :

(1) A director or officer shall not be liable to pay compensation to a company by reason of section 229 or under the general law in respect of his or her business judgment unless it is made to appear to the relevant court that at the relevant time the director or officer ·

(a) had an unauthorised interest in the transaction of the company to which the judgment relates;


(b) had not informed himself or herself to an appropriate extent about the subject of the judgment;

(c) did not act in good faith for a proper purpose; or

(d) acted in a manner that a reasonable director with his or her training and experience could not possible regard as being for the benefit of the company.

(2) In this section 'business judgment" means a lawful judgment made for the conduct of the company's business operations and, without affecting the generality of the expression, includes a judgment as to -

(e) the company's goals;

(f) plans and budgeting;

(g) promotion of the company's business;

(h) acquiring assets and disposing of assets;

(i) raising or altering capital;

O') obtaining or giving credit;

(k) deploying the company's personnel; or

(l) trading

but does not include a judgment as to -

(m) matters relating principally to the constitution of the company or the conduct of meetings within the company;

(n) appointment of executive officers; or

(o) the company's solvency.

(3) Sub-section (1) does not operate in relation to any other provision of this Act or any other Act or any Regulation under which a director or officer may be liable to make a payment in relation to any of his or her acts or omissions as a director or officer.

(4) In circumstances where, in the absence of this provision, a director or officer would not be liable to pay compensation to the company this provision does not operate to impose any such liability.


The point of the rule is to encourage investment by marking out a safe harbour. The safe harbour is a well-informed, disinterested transaction undertaken in good faith. A business judgment rule will encourage good business practice - practice that not only has an eye to avoiding misconduct but an eye to creating investment and profit.

This is a very high priority for further corporate law reform. The Corporate Law Reform Bill covers four different areas - electronic clearance, voluntary

administration, directors’ duties, and related party transactions. The first two should proceed immediately, directors' duties should be reworked to include the business judgment rule and related party transactions should be completely revamped.

Aside from these issues, the question of statutory disclosure is still very much on the agenda. The Attorney General has repeatedly made it known that he wishes to introduce a scheme of statutory continuous disclosure. In September 1991, the Companies and Securities Advisory Committee issued a report recommending the introduction of statutory-based continuous disclosure for all listed companies, and

companies with gross assets in excess of $10 million, In a response of February 1992, the Australian Securities Commission supported statutory continuous disclosure but on a more limited basis.

If markets are to operate at maximum efficiency they need to be fully informed. Disclosure is essential to market operation. If equities in companies are to be continuously traded, then information affecting their value must be continuously available. I am not convinced that quarterly reports are sufficient, but neither am I

convinced that the right place to send continuous information is to government regulators. The information must be put into the market.

The Stock Exchange listing rules as at 1st January 1992 require immediate notification o f :

3A 1. Any information which -

(a) is likely materially to affect the price of the securities of the listed companies;

(b) is necessary to avoid the establishment or continuation of a false market in the company's securities; or

(c) investors and their professional advisers would reasonably require, and reasonably expect to be disclosed to the market, for the purpose of making an informed assessment of -

(i) the assets and liabilities, financial position, profits and losses, and prospects of the listed companies; and

(ii) the rights attaching to securities of the listed companies.

The Australian Stock Exchange has power to obtain court orders to enforce its listing rules under Section 777 of the Corporations Law as does the Australian Securities


Commission or "an aggrieved person". Critics of the ASX will argue that it has not adequately policed its rules in the past. It now has statutory standing to do so. If it is t fearful of using that power because it may have to lodge an undertaking as to

damages, then the requirement that it give an undertaking should be removed. The Stock Exchange could take up law enforcement in this area. Of course the ASC and private individuals have the right to do so as well.

Indeed, 1 believe there should be more scope for private law enforcement in this area. Private individuals adversely affected by company decisions are highly motivated - perhaps more so than government bodies. The introduction of a statutory derivative action would widen the opportunity for aggrieved shareholders to restrain errant


In doctoring the corporate malaise we should always try to think of solutions which will protect best business practice, which includes encouraging investment and profit. In the regulation of the corporate world there is a role for government institutions,

private institutions and private citizens. There is no reason to think that the government should have a monopoly on civil law enforcement. Doctoring the corporate malaise involves harmonising the strengths of different institutions to complement each other. And doctoring the corporate malaise must have an

economic focus as well as a legalistic one.