Director's Counsel: When the regulator takes action

Professor Bob Baxt reviews the Australian Securities and Investments Commission’s decision to take action against KPMG, the auditor of the failed Westpoint Group of companies.

On 13 October 2008, the Australian Securities and Investments Commission (ASIC) announced it had started action in the Supreme Court of Victoria against an accountancy firm, KPMG. The action concerns KPMG’s alleged failure in auditing the companies in the Westpoint Group. This group collapsed in 2006 with estimated losses of more than $300 million.

This is one of the very few occasions where ASIC has used its power under section 50 of the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) to proceed on behalf of a company to recover property or damages.

ASIC’s powers under this section are very wide. It can bring civil proceedings in the name of the relevant company to recover property and damages and to rectify wrongs against the company where it sees this to be in the public interest.

A highly publicised previous occasion where ASIC, or rather its predecessor, the Australian Securities Commission (ASC), used this power was in the case of ASC v Deloitte Touche Tohmatsu (1996) 14 ACLC 1486; 21 ASCR 332 (Deloitte).

The Deloitte case was very important because it was the first time the previous regulator had sought to rely on conferred powers to, in effect, stand in the shoes of the shareholders of the company in seeking remedies against alleged wrongdoers.

Justice Lindgren held that in arriving at a decision to take action in the name of the company under section 50, the ASC was required to look at the operation of the rule in Foss v Harbottle (1843) 2 Hare 461 and to determine whether this was an appropriate occasion for it to bring an action in the name of a company.

After all, the rule in Foss v Harbottle had been in operation for many years – as had several common law exceptions to that rule. These principles operated so as to protect shareholders in a company and to allow them to seek action on behalf of a company if the directors thought not to pursue action against third parties, or even against themselves, in the context of a breach of duty.

Justice Lindgren’s decision in Deloitte was overturned by the Full Federal Court comprising Justices Beaumont, Drummond and Sundberg.

In that case, they ruled unanimously that section 50 of the ASIC Act provided the regulator with very wide discretion. It called for the regulator to form a view, based on the information available to it and in the context of the public interest issues that arose, whether or not to bring an action in the name of the company against alleged wrongdoers. The Justices’ view was that although decisions under section 50 were not “judicially unreviewable”, they were by their very nature not easily subjected to review.

Accordingly, the review could only be granted where the decision-maker failed to address the correct legal questions or where the decision-maker’s process of reasoning was unreasonable.

The court ruled that in the decision of Deloitte, ASIC had followed the appropriate processes.

Section 50 has also been used on minor occasions by ASIC – for example, Carey v ASIC (2008) 247 ALR 772; (2008) 67 ACSR 210; [2008] FCA 963 and Somerville v Australian Securities Commission (1993) 11 ACSR 595; (1993) 11 ACLC 1132 (FCA).

In announcing the action in October, ASIC chairman, Tony D’Aloisio, noted: “ASIC sees a clear public interest in using its powers in these circumstances to pursue compensation for the benefit of Westpoint investors.”

These proceedings are being initiated as a follow on to other steps that are ready to be taken by ASIC against various directors and officers of the Westpoint Group, as well as actions against the trustee and several financial services licensees.

ASIC’s media release on 13 October 2008 lists a number of actions that had been taken by ASIC.

Auditors, who must act independently, have specific duties imposed upon them by the legislation (Part 2M4 of the Corporations Act).

For ASIC to establish that the auditors have not performed their responsibilities appropriately raises matters of significant importance that will no doubt be challenged by KPMG. Section 311 of the Corporations Act sets out a range of matters that may raise questions for auditors if they fail to comply with statutory requirements. The auditor’s report needs to comply with the provisions of section 307 and others of the Corporations Act.

There have been many interesting cases involving the obligations of auditors and it will be fascinating to see how the litigation in this matter progresses.

The Corporations Act contains a number of avenues available to companies and their shareholders to seek remedies against those who may have breached the law. In addition to the series of provisions in sections 180 – 183, which deal directly with the duties of directors in the context of duties to care, good faith and so on, there are also important provisions which provide for avenues to be pursued where companies engage in insolvent or fraudulent trading. However, the role of section 50 of the ASIC Act is much broader.

One provision of the Corporations Act which, in the context of the overall structure of our corporations legislation, has not been used as effectively as it may have been in dealing with breaches of the law – that is, breaches of the statute – is section 1324.

This provision has not been the subject of a great deal of litigation. However, the provision has now been clearly identified as a valid and effective avenue for persons to proceed against companies and their officers, directors, auditors and so on.

KPMG will no doubt vigorously defend the litigation in the Westpoint matter. It will be a long and drawn-out affair. The Westpoint collapse is quite a significant one involving fascinating issues related to the operation of companies that sell different types of financial products.

The litigation is particularly important in light of the continuing crisis affecting global financial markets and the steps being taken by governments all over the world to protect the deposits and investments of the public.

This particular piece of litigation, which has obviously been considered very carefully by ASIC before deciding to institute proceedings, will potentially play a very significant role in the history of regulation in this area of the law.

Directors of all companies will need to be aware of the ramifications of the legislation and the fact that ASIC is now turning its mind to using its various powers to ensure that companies are properly administered, that directors and officers behave appropriately and that the law is not breached.

Professor Bob Baxt AO FAICD(Life) is a partner at Freehills and chairman of the AICD Law Committee