By Greg Golding, King & Wood Mallesons, Sydney

The adverse conditions caused by a change in the Australian business environment have been apparent over recent years. The regulatory consequences of that change are still being worked through. Before the second half of 2007, Australia and global markets enjoyed favourable financial market conditions that had most noticeably been marked by a private equity boom. The onset of the Global Financial Crisis in the second half of 2007 resulted in a deep and continuing financial crisis that remains unresolved. This has led to a number of Australian entities suffering financial difficulty and a number of investors suffering significant losses in the Australian capital markets. To be sure, boom and bust is a recurring feature of Australian securities markets and the role of the regulator is not that of a guarantor of investors’ finances.

In the early 1990’s it was argued that one solution to the perceived regulatory failings arising out of the entrepreneur collapses of the late 1980s was a redesigned securities law which employed an enforcement pyramid where the regulator had available to it a broader range of remedies. The availability of that enforcement pyramid would allow for more appropriate sanctions based on the degree of culpability of the individual. It was argued that such a range of sanctions was particularly important in addressing the position of the director.

Traditionally, the director’s position has been primarily regulated by the common law duties of care, skill and diligence and loyalty, and the statutory codification of those duties in the 1970’s. It has been persuasively argued that the balance of those standards of conduct are appropriate and have worked well in Australia in recent years when assessed by reference to the reported case law. However the traditional remedies are not the end of the story for the director in 2012. There are a broad range of sanctions that are now part of the regulatory enforcement pyramid as it applies to the director. The regulatory enforcement pyramid as applied to the director in 2012 from apex to base includes the following types of liabilities: (i) criminal; (ii) disqualification from managing corporations; (iii) civil penalty; (iv) civil liability; and (v) a fine or infringement notice.

The primary new initiative of the 1990’s was the introduction of civil penalty liability, as recommended by the Cooney Committee in 1989. Where a court declaration of contravention is obtained, ASIC may seek a pecuniary penalty order, a disqualification order or a compensation order. The court may make a compensation order whether or not it makes a declaration of contravention. A company may seek a compensation order but not a pecuniary penalty order or a disqualification order. Where a court has declared that a person has contravened a civil penalty provision, the court may disqualify that person from managing companies for a period that the court considers appropriate.

The civil penalty regime has gradually expanded over the last decade to encompass a broad range of conduct that has potential application to the director. Initially the effectiveness of the remedy was subject to some debate. However, most commentators now believe that the remedy has been a success.  It is understandable that issues of directors duties are more evident in the civil penalty sphere than in class action claims in view of the initial focus on this area in introducing the sanction and the fact that ASIC (rather than the DPP) has the primary responsibility for enforcement of this regime. From analysis of various case studies such as ASIC v Rich, Fortescue Metals, Citrofresh, James Hardie and Centro (each of which are described in further detail in the attached paper) it is possible to draw several conclusions.

First the time periods involved in each of these case studies (other than Centro) are extreme and is unfortunate from a regulatory policy perspective. It would be hoped that these cases represent anomalies rather than a feature of this type litigation going forward. It has been said by an experienced and influential company director that it is not the balance of the legal requirements that are at fault but the time periods that are involved in establishing lack of culpability. In that context it was suggested that if a director is sued it typically takes around 7 years to defend the claim and in the meantime their career is shot to pieces.

Second, the combination of proceedings based on violation of directors duties and disclosure violations reflected in these proceedings reflects a measured and appropriate regulatory response to the regulatory issues raised by matters of that nature, if the allegations are correct. The focus on remedial orders against directors involved in alleged wrongdoing, rather than the entities that have suffered loss appears an appropriate regulatory strategy.

Third, the limitations of the civil penalty regime need to be acknowledged by the regulator. A pecuniary penalty of $200,000 for an individual, the compensation order and the banning order will not be appropriate for significant wrongdoing. The issues in this area are well illustrated by the penalty decision of the civil penalty imposed on the prominent public identity Steve Vizard for breach of fiduciary duty. The judge in that case considered the financial penalty imposed of $130,000 to be low and suggested that Parliament may need to review the upper amount that may be imposed. Further, the judge doubled the banning period proposed by ASIC to better reflect objectives of deterrence. Notwithstanding those steps there was still public criticism of the lightness of the penalty imposed.

It is evident that a much broader enforcement pyramid is in existence that is relevant to the company director than applied with prior corporate collapses. A director considering his or her liability position in 2012 faces much broader liability concerns than those based on the traditional areas of directors duties. The creative use of civil penalty provisions of the Corporations Act remain very prospective sanctions available to ASIC. The primary message of this paper is simple. In 2012 the director lives in a much more complicated world of potential liability than that described by the traditional bounds of directors duties.

*  This article, co-authored with Laura Steinke of King & Wood Mallesons, was prepared for the University of New South Wales: 2012 Directors Duties Seminar.  The full version of the article which analyses further developments in the regulatory enforcement pyramid, including various class actions and general criminal prosecutions, is here.