This article first appeared in the October 2011 issue of Boardroom magazine.
Comparisons between the Nathans and Centro cases were always inevitable. They went before the court at much the same time and both involved a failure by directors to disclose material information.
Both Judges accepted that the director defendants had not intentionally misled the market or acted dishonestly but said that the matters which had not been disclosed should have been well-known to the Board. Despite these similarities, however, the sentencing in the Nathans case was much harsher than in the Centro case.
Detailed declarations of contravention were issued against the six non-executive Centro directors but they received no further penalty. Two of the Nathans directors, by contrast, were sentenced to prison terms of just over two years and the third to nine months’ home detention and 300 hours community work. All three were ordered to make substantial payments in reparation.
Because sentences are specific to the facts of the case, and to the circumstances of each defendant, they cannot easily be compared. It may be instructive, however, to look at the factors which the two Judges took into account in making their decisions.
But first, a very brief synopsis of the two cases.
The directors of Nathans Finance Limited were charged under the Securities Act 1978 with issuing offer documents containing untrue statements relating to the nature and level of Nathans’ exposure to VTL Group Limited. Nathans was a wholly-owned subsidiary of VTL.
Centro is an Australian development company specialising in shopping malls. It was a very high growth, highly leveraged operation but was badly hit by the 2007 global financial crisis. The directors were found to have breached their directors’ duties after the company’s 2007 financial statements failed properly to disclose significant short-term liabilities and related-party guarantees.
The Judge accepted ASIC’s submission that the conduct of the Centro directors was “not merely that of neglectful inattention” but said that they had operated in accordance with a set of well-established corporate governance practices and had relied on expert accounting advice and on a number of “safety nets” designed to ensure that the accounts were true and correct.
That those safety nets had failed was “due to no fault of the non-executive directors”. Both Centro’s management team and the external auditors had assured the Board that the financial reports were compliant.
The Judge also felt that the widespread publicity and the associated embarrassment suffered by each of the directors satisfied “the principle of general deterrence” and much reduced the need for any further punishment.
Other considerations the Judge offered for leniency were:
- that each man had an hitherto unblemished history as a director
- while each had relied “too heavily on management and expert auditors”, they would be unlikely to do so again
- they had not sought to conceal the errors but had taken immediate steps to investigate what had occurred and to inform the market, and
- testimony from highly respected sources was that the men were all of high calibre and still had a valuable contribution to make.
In contrast, the Auckland High Court Judge in the Nathan’s case considered that their offending was at the upper end of the scale – not dishonesty, but reckless or gross negligence. Their performance as directors was “inept” and had fallen “far below” the standards that investors were entitled to expect.
The reason they had been able honestly to believe that VTL could repay its debts to Nathans was that there was always “a big deal” just around the corner which would salvage the situation – “even though all the objective evidence pointed in the opposite direction”.
The Nathans directors also argued that they had relied on external advice but the defence was rejected for two reasons: issues around the quality of the data available to the advisors, and the failure by the directors to exercise their own judgement based on their own knowledge of the company’s affairs.
“The quality of any advice is only as good as the information provided to the professional, on the basis of which he or she is asked to advise. In considering the extent to which directors are entitled to rely on external advice, some assessment must be made of the prime information on which the adviser acted and whether he or she was on inquiry as to the accuracy of that information,” the Judge said.
And: “The statutory duty for ensuring that offer documents go into the market without misleading statements rests on directors of the issuer. Directors have a non-delegable duty to form their own opinions on that issue, in reliance on information provided by others that they have no reason to suspect may be wrong.
“The problem for the directors, in this particular case, is that they, in effect, purported to delegate to senior management the task of determining whether the investment statement and prospectus were “compliant” with regulatory requirements and failed to bring independent minds to bear on this topic”.
Key take-outs for directors from the two cases are:
- reliance on expert advice will provide a defence, or at least a strong mitigating factor in relation to the level of sanction imposed by the courts, PROVIDED
- directors have exercised their own independent judgement in relation to the information before them, and
- have satisfied themselves that the basis on which the external advice was prepared, including the nature of the advisors’ brief, was sufficiently robust to guarantee the reliability and quality of the advice.
Tim Williams is a partner at Chapman Tripp specialising in investment funds and savings products and in securities.