Examining criminal sanctions

Professor Bob Baxt explains why the case for increased penalties under the Corporations Act continues to grow stronger.

As a result of two unconnected events, one arising out of the decision of Justice Murphy in the federal court of Australia in the case of ASIC v Australian Property Custodian Holdings Ltd (Receivers and Managers Appointed) (In Liquidation) (Controllers Appointed) [2014] FCA 1308 (the Prime Trust case), the other being the Financial System Inquiry chaired by David Murray (the Murray Report), the ongoing push for the introduction of harsher penalties into the Corporations Act 2001 (the Act) and related legislation, led by Greg Medcraft, chairman of the Australian Securities and Investments Commission (ASIC), has been given even greater emphasis than before.

Medcraft has been campaigning for a considerable period of time for an increase in the penalties that may be awarded by our courts for breaches of major provisions of the Act and related legislation.

While criminal sanctions may be sought, and have in the past been pursued with some enthusiasm by ASIC, the success rate in this area of corporate and securities law has been rather dismal.

More recently there have been some successful prosecutions in the criminal area of breaches of insider trading and other market manipulation practices.

But the cases involving potential criminal sanctions against directors for major collapses of companies and other potential breaches of the law have been quite startlingly absent. Indeed, the story that we have seen develop in recent years has been one in which the regulator, ASIC, has often “lowered its sights” in seeking the penalties that may be relevant in the context of the alleged breach of the law, and gone to the courts with an agreed penalty regime to be imposed on the relevant director or manager because of the great difficulty that ASIC has faced in seeking all sanctions.

A classic example of this approach, one that has been the subject of some debate, and some disagreement between judges sitting on both the supreme court and the federal court of Australia, was the Ingleby case (ASIC v Ingleby (2013 VSCA 49 )).

It highlights the dilemma that the regulator faces. Now, as a result of the decision in the Prime Trust case referred to earlier, the debate has been reignited, as this note will illustrate.

The Murray Report, which was published on 7 December, has been referred to the Federal Government which must make a decision on which of the recommendations put forward might be adopted.

Chapters four and five of the Murray Report contain significant recommendations to increase the powers vested in ASIC, and other regulators such as the Australian Prudential Regulatory Authority, and for increased resources to be “voted” to the regulation of our corporate law.

David Murray has come out very strongly in favour for increased penalties. I will not comment on the Murray Report recommendations, this should be the subject of a separate note and should await decision from the Federal Government. I will limit my detailed comments in this note to the Prime Trust case.

ASIC v APCHL

In the first decision, ASIC v Australian Property Custodian Holdings Ltd (Receivers and Managers Appointed) (In Liquidation) (No. 3) [2013] FCA 1342, Justice Murphy held that the relevant directors of Australian Property Custodian Holdings Ltd (APCHL), namely Lewski, Wooldridge Butler, Jaques, and Clarke, had breached various provisions of the Act relating to the administration of management investment schemes.  It is not necessary for our purposes to delve into the details of the allegations; suffice to say that it involved the extraordinary claimant of a special fee to Lewski, which it was alleged amounted to breaches of various provisions of the Act as well as breaches of the common law duties of the directors. Justice Murphy held that no benefits were received by the members of the relevant trust arrangement involved while the directors received significant benefits, namely in the form of the fee paid to Lewski. 

Following the finding of liability, Justice Murphy delivered the penalty judgment, which has been noted at the commencement of this note.  It is sufficient for our purposes to describe that he imposed a 15-year disqualification period on Lewski, together with a monetary penalty of $230,000 (in which he aggregated two major breaches of the law); smaller penalties and disqualification periods were imposed on the other directors. In the view of Justice Murphy, Lewski had shown a lack of contrition in the relevant circumstances. The judge wished to deliver a strong message to the community that breaches of this kind should not be countenanced. 

It is the largest disqualification and penalty proceedings for some years that ASIC has been involved in. The directors, apart from defending their actions and indicating that they were not aware of any breach, sought to rely on the discretion of the judge to forgive them the breaches pursuant to sections 1317S and 1318 of the Act. It has been very rare for judges to exercise their discretion under these provisions and Justice Murphy felt that the directors had not acted honestly; the contraventions were very serious; and certainly in the case of Lewski no contrition had been established. The directors are all appealing both their conviction of the relevant rules.

ASIC was naturally pleased with this decision but, commissioner Greg Tanzer was unable to answer questions relating to why criminal proceedings had not been brought against the relevant directors.  He did state that on the advice of the commonwealth director of public prosecutions it was resolved that there was insufficient evidence to support a criminal prosecution. 

Potential outcome

Does this decision support the proposition put forward by Medcraft, and Murray, that penalties under the legislation should be increased?  It is my view even if the level of penalties that might be imposed were multiplied significantly, it would make no difference to the burning question as to why criminal sanctions have not been sought. Australian courts are reluctant to impose criminal penalties even in cases where they cry out for possible consideration. One can only be reminded of the remarks made by the former Justice Finkelstein to the Australian federal court, in the Vizard litigation (ASIC vs Vizard (2005) 54 ACSR  394) when ASIC pursued an insider trading case but did not seek criminal sanctions, only civil sanctions.

The burden of proof in criminal cases is extremely heavy. This contrasts to the way in which these matters are pursued in the US where we have a multiplicity of different approaches that perhaps provide regulators with greater incentives to seek out and pursue persons who they believe have broken the law. The whistleblowing provisions in US law enable the US Securities and Exchange Commission to offer monetary rewards of many millions of dollars to whistleblowers to “dob in” people who may break the law. Judges are much more willing to impose criminal sanctions in cases. Criminal cartel behaviour under anti-trust law in the US often results in significant jail terms being imposed on directors of companies. No prosecutions have yet been brought in Australia. Is this because our directors who are unfortunate to be caught up in these types of activities somehow behave in a more prudent fashion than directors in the US? Or is it part of the system of regulation that exists here, which does not single out the pursuit of criminal sanction?

The Independent Commission Against Corruption regime in New South Wales has resulted in a number of corruption and related cases. But, is there a parallel need for similar tough actions to be taken in areas of corporate and securities law where the burden of proof is very high?

The relevant directors, in defending their particular prosecutions, as well as the penalty and disqualification judgments, argued that they were not aware that any breach of duty was being committed; they believe that there were genuine business and other arguments in favour of the arrangements that were put in place, and that they had taken the appropriate care and diligence necessary in order to pursue the particular arrangements that were set up. It is not surprising that ASIC has pursued cases such as this because it is very concerned about the operation of the management investment scheme provisions of the legislation. It is also concerned about how they may be the subject of some manipulation in some of the large corporate collapses that have occurred.

The penalties that were eventually imposed were amongst the highest in recent years. Nevertheless, many persons who are familiar with developments in the US will note that the penalties that have been imposed in this case were quite small in comparison to the huge penalties that are able to be imposed in the US.  I shall comment on that aspect again shortly.