All articles in Volume 11 Issue 8

Integrated reporting draft raises director liability concerns

Issue 8

There have been mixed responses from Australian directors to the Consultation Draft of the International Integrated Reporting Framework, with many concerned it could increase their liabilities.

The draft framework, recently released by the International Integrated Reporting Council (IIRC) through 15 events around the world, creates the foundations for a new corporate reporting model and introduces the concept of "six capitals" – a prism through which organisations should assess, and then report, the degree to which they are creating, diminishing or destroying value over time.

Dr Carol Adams GAICD, the founding director of Integrated Horizons and member of the IIRC's Capitals Technical Collaboration Group, expects the framework, if accepted, to change the nature of corporate reporting, facilitate sound management and affect the work of boards.

She says while the short and medium term are not ignored, integrated reporting stands out from other reporting frameworks because of its emphasis on, and encouragement of, long-term thinking. The requirement to provide information on an organisation's strategy will encourage senior executives and boards to think long term.

"The concept of creating value will also encourage senior executives and boards to think about performance more broadly than the financial bottom line. Value creation goes beyond financial returns to providers of capital and considers the impact on the other capitals."

Australia Post chairman John Stanhope FAICD, who helped launch the draft in Australia, welcomes the framework, noting it has been "informed by a prototype and responses to a discussion paper from the IIRC". "And, it continues to be informed by trials in many countries and global activity."

But Stanhope notes: "There is still discussion to be had on two issues and both concern directors. The first is how will integrated reporting be assured – what will the level of assurance be and who will do it? The second is directors' liability. The framework suggests that companies should talk about their business models and how sustainable they are, and that they should give some indication about the future. But directors don't like talking about the future because they are concerned about their liability. This needs more discussion on this. There has been talk about safe harbours and the like,but that may require a regulator and perhaps more legislation. For Australia to have integrated reporting, this issue would have to be addressed."

Michael Coleman FAICD, deputy chairman of the Financial Reporting Council and a member of the audit committee of the Reserve Bank of Australia, says the draft is pretty consistent with what was expected.

He says: "Many directors are concerned that this could be an additional reporting requirement ... But if you treat the concept as a guide to the way in which you should prepare your management discussion and analysis report, or operating and financial review, then it's heading in a way that most of us can live with. But like all these things, the devil is in the detail."

Coleman, who is also chairman of Company Directors' reporting committee, adds: "If Australia is asked to adopt this type of report, until such time as there is a safe harbour, I think a lot of directors will be very careful and cautious in what they do about forward-looking commentary. It's an issue of director liability."

Former president of the Business Council of Australia Graham Bradley FAICD is also concerned about the director liability issue. "At the end of the day, busy boards of directors must sign off on all major corporate reports, including integrated reports," he says. "It is dangerous to delegate this task to management following the James Hardie and Centro cases."

Bradley believes that encouraging public companies to provide more useful and user-friendly information to shareholders is a worthy aim. But he says: "It is a pity that the IIRC has gone well beyond a principles-based approach and produced the draft, which, despite disclaimers, appears to be highly prescriptive.

"The draft introduces new reporting language and jargon, which may prove to be more academic than useful in practice. A prime example is a company's 'capitals'. The metaphor 'human capital' (which many feel is a rather ugly way to describe employees) has now been extended to 'manufactured capital', 'social capital', 'relationship capital' and 'natural capital'. A company is asked to report how it uses, grows or interacts with these 'capitals'. This new language is vague and will cause considerable debate and uncertainty."

Bradley questions how much value the framework will add for public companies that already take their reporting to stakeholders seriously, with lengthy annual reports, remuneration reports and sustainability reports. "I suspect many companies will find that following the framework will lead to much longer, but not necessarily more useful, annual reports. Indeed, the framework sets up a tension between its call for 'completeness' and its principle of 'concise reporting'," he says.

"I would prefer to see the draft framed in less prescriptive terms, with greater emphasis on key principles that should guide the quality of reporting to stakeholders. Also, I feel that the framework has an excessive focus on reporting of 'opportunities and risks'. This runs the danger of making annual reports too much like prospectuses, filled with uninformative boilerplate about the obvious risks inherent in any business in the modern world.

"Similarly, the push for more 'future-oriented information' will be of particular concern for boards given the self-evident liability risks of forecasting in a volatile global business environment. The risk is that lengthy cautionary statements and extensive listing of key assumptions will erode the informational value of mandating more detailed future outlook statements." Bradley adds: "The draft framework seems to assume that a company will produce one comprehensive and integrated report to stakeholders. I see corporate reporting evolving differently.

"For example, many companies are reducing the size of their annual report and choosing to place detailed descriptions of their assets and business operations on their websites, where it can be regularly updated. Such information can be kept more current than in the case with annual reports in the past. Similarly, webcasting analyst briefings make them readily available to ordinary shareholders.

Accordingly, companies are moving towards a diverse approach to reporting that is at odds with the draft framework but may be more efficient and effective." Responses to the consultation paper are due by 15 July 2013. Company Directors is currently compiling its response on behalf of members.

Directors worry about Government's business understanding

The relationship between business and the Federal Government has further deteriorated, while growing regulation and red tape has become a major worry for directors, according to the latest Director Sentiment Index (DSI).

This biannual survey of over 500 Australian chairmen and directors, compiled by research company Ipsos on behalf of the Australian Institute of Company Directors, found that only eight per cent of directors surveyed (down from 12 per cent six months earlier) believe the Federal Government understands business. Conversely, more than 80 per cent – up from 70 per cent in November 2012 – believe that the Federal Government does not understand business. In contrast, around half felt the Federal Opposition understands the commercial world.

Commenting on these findings, Steve Burrell MAICD, Company Directors' general manager of communications and public affairs, says: "While there is a clear difference between the view of directors about the current Government, as opposed to the Coalition, there is still a feeling that, overall, whoever is running the show doesn't have a great understanding of the drivers of business and some of the issues that business confronts. It's not exactly a plague on both houses, but it does indicate a general understanding in the business community that there is a problem in Canberra regardless of who is actually steering the ship."

Meanwhile, the DSI also found that, while still negative, overall director sentiment has improved from its lowest level, recorded in the November 2012 survey, on the back of rising optimism about the future health of the Asian economy, as well as expected growth in the Australian share market.

"Things are still very tough, but slightly better, and there is a slightly better spring in directors' steps than there was in the depths of the second half of last year when things were looking very gloomy indeed," says Burrell.

Almost 50 per cent of directors believe the Asian economy will be strong over the next 12 months, up from 31 per cent last survey. In addition, nearly 70 per cent expect the Australian share market to grow in the coming year. "It is a positive sign that overall sentiment is improving on the back of some encouraging data about the future of the global economy," says John Colvin, Company Directors' CEO.

"While more than 40 per cent of directors claimed the growth of their businesses had weakened over the past six months, directors are now equally optimistic and pessimistic (about 30 per cent respectively) about the general business outlook and the outlook for their own sector."

The DSI found that the high value of the Australian dollar continues to be a major concern for directors. They rank it as the top economic challenge facing Australia, followed by global economic uncertainty and growing concerns about the amount of regulation and red tape. The latter jumped from seventh place to be ranked the equal second most significant economic challenge facing Australian businesses. It is also rated as the second biggest impediment to productivity growth, after general economic conditions.

According to Colvin, rising regulation distorts the operation of the market, slows up the engines of growth and job creation and stifles wealth creation in the economy.

"It is a drag on entrepreneurial activity and distorts business behaviour," he says. "Directors are saying that deregulation is a crucial part of the agenda for boosting national productivity and must be a priority for government."

The DSI reveals that directors believe that the level of red tape and board time spent on regulatory compliance has increased over the past 12 months, with regulation surrounding workplace health and safety and employing workers rated as having the highest effect on productivity.

According to Burrell, the measure of sentiment towards regulation, legal issues, reporting issues and the carbon tax is still deep in negative territory. "These are all about government policy and impediments to business decision-making. This tells us something very interesting: even though directors are relatively optimistic about their firms going forward, and general conditions, they are clearly saying they are being held back by government policies, particularly around regulation. This and previous surveys have identified this as being a major issue for productivity and decision-making and business operations generally."

Class actions: what to expect in 2013

A new report predicts interesting times ahead in 2013, with some of the largest natural disaster and public liability class actions yet seen due for trial in 2013 and rulings expected on the ability of companies and directors to have recourse to directors' and officers' (D&O) insurance proceeds ahead of class action claimants.

The report, Class Actions in Australia – The Year in Review 2012, compiled by King & Wood Mallesons (KWM), also predicts that the number of mass tort and product liability and other consumer class actions will rise again in 2013 and that financial product class action claims will continue throughout the year.

"Moving forward, we can also expect to see further diversification in the types of class actions that are being launched," says Moira Saville, a KWM partner and co-author of the report.

The report notes that awareness of the challenges posed by class actions are clearly increasing. For example, in KWM's 2012 survey of company directors, 30 per cent of respondents considered class actions to be a significant or increasing threat. That is a stark contrast to the findings of the 2011 survey, where no respondents considered class actions to be such a threat.

2012 proved to be a watershed year for class actions, with the record $200 million settlement in the Centro class actions bringing the total value of securities class action settlements over the past 20 years to more than $1 billion. 2012 also saw more settlements than any other year in the history of Australia's class action regimes, with a total of 13 class actions settled, the report notes.

In addition, class actions in 2012 reaffirmed that insurance policies remain a key factor in determining whether litigation is started and also influence how proceedings are run and settled. For example, when announcing the start of the Maryville Black Saturday bushfire class action in August 2012, Maurice Blackburn stated: "Insurance will be a very substantial contributor to any outcome of this case." Similarly, it was also reported that the viability of any class action in relation to the Hastie Group (for alleged breaches of disclosure requirements in relation to forecast downgrades) would depend on whether there were any funds remaining within the collapsed group, or if the company had paid-up D&O liability insurance.

The report also notes that some recent developments have also created uncertainty as to whether D&O insurance may be used to fund defence costs. Of significance in 2012 was the New Zealand Court of Appeal's unanimous decision in proceedings relating to the failed New Zealand finance company, Bridgecorp. This decision overturned an earlier ruling which prevented Bridgecorp's directors and officers from accessing their D&O defence costs in circumstances where the third party claims were likely to exceed the available limit.

"The practical effect of the first instance decision was that a statutory charge existed on the available limit of the D&O cover, which had to be quarantined for a potential liability judgment and was not available to fund defence costs. If the insurer advanced defence costs in these circumstances, it would potentially do so as a volunteer without any reduction to the policy limit," notes the report.

"New Zealand decisions are not binding in Australia, but they may be considered persuasive in Australian jurisdictions. Accordingly, insurers have sought to have the position regarding defence costs clarified in Australia."

New migration laws introduce more liability for directors

Company directors are being warned to stay vigilant when it comes to the employment of staff following amendments to the Migration Act 1958.

As a result of these amendments, there will soon be non-fault civil penalty provisions in addition to the existing "criminal offence" regime and a defence to criminal offences and civil penalty provisions, says Holding Redlich partner Paul Hardman.

He says the Migration Amendment (Reform of Employer Sanctions) Act 2013 also introduces an extension of liability to the directors and executive officers of businesses in certain circumstances.

The Migration Act 1958 contains a number of provisions prohibiting employers from allowing "unlawful non-citizens" (foreign citizens who do not hold a valid visa to be in Australia) and "lawful non-citizens" (foreign citizens who hold a valid visa to be in Australia) to work in Australia either without permission or in breach of work related conditions on their visa. Employers are liable for fines of up to $102,000 for ordinary breaches and $255,000 for aggravated breaches of the relevant provisions of the Act. Under the existing provisions, an employer could only be found guilty if the prosecution could prove that an employer knew that a person did not have the appropriate right to work in Australia and allowed him or her to work despite that knowledge.

"This element has proven difficult to establish and is considered by the Government to be ineffective as a deterrent against preventing persons without valid work rights from working in Australia," says Hardman. The "physical" elements of the existing offences, allowing an unlawful or lawful non-citizen to work, will not be materially altered by the amendments. Rather, civil penalty provisions will be introduced into the regime to allow prosecutors to enforce breaches of the Act even if the "fault" element cannot be established.

"Ultimately, this means that employers could face penalties where they employ a person who, unknown to them, does not have a valid right to engage in work (or that type of work) in Australia," notes Hardman.

Employers are liable for fines up to $76,500 for breaching the civil penalty provisions.

The amendment creates a specific defence to the criminal offences and the civil penalty provisions where employers can evidence that they have taken reasonable steps at reasonable times to verify that a worker is not an unlawful non-citizen or a lawful non-citizen in breach of their visa conditions.

However, the amendments also mean executive officers will be personally liable for contraventions of the criminal offence and civil penalty provisions by the company of which they are a director where the executive officer knew that, or was negligent to whether, the contraventions would occur; was in a position to influence the conduct of the employer in relation to the contravention; and failed to take reasonable steps to prevent work-related contraventions.

So what can directors do?

In light of the new non-fault civil remedy provisions, and the extension of liability to executive officers, Hardman says directors should ensure their companies have taken steps to comply with the new penalty regime by:

  • Preparing or refining employee screening procedures or implementing mandatory reviews of all new (and existing) employees' work rights.
  • Reviewing contractual obligations with third party labour referrers and/or hire companies to clarify the responsibility of checking work rights of proposed employees.
  • Registering for access to Department of Immigration and Citizenship's (DIAC) Visa Entitlement Verification Online (VEVO) system.

Collaboration and function trump prestige in boardroom relations

When the chairman and CEO create "chemistry", they can allow the structure of their mandates to serve their relationship and the collaboration it generates. But when chemistry is lacking, the relationship becomes the primary driver of both governance and growth.

This is the view of Omer Soker, CEO of The Ethics of Success Corporation, who warns that it is because of their big personalities, fierce intellects and high stakes that the chairman and CEO then must let go of their egos and function within defined boundaries.

There is no evidence to show that a dysfunctional relationship between the two benefits an organisation and it is a sage reminder that the same rules of engagement and expectations apply to directors at a board meeting, as they do for junior staffers in a departmental gathering.

"There is nothing unique or mysterious about board meetings. It's just a group of human beings with a job to do and a company to serve, where collaboration and function must take precedence over prestige," says Soker. He highlights four areas to consider for improved boardroom relations:

  1. A seat on the board is not a passive perk, but an active responsibility. Directors who do their homework, and come prepared to engage the CEO in robust discussion, add value at every meeting. CEOs want access to the diversity of opinion directors can bring and need to embrace the open conflict and debate it inevitably ignites. Directors are there to create the spark.
  2. The chairman cannot seek to control, constrict or rein in the CEO by force, because the relationship pattern established here will be repeated and cascaded throughout the organisation. A restricted CEO restricts those below him or her. The CEO needs to be either engaged or his or her future needs to be re-considered – just like all other healthy relationships.
  3. Directors must align their values and objectives with those of the organisation and become a cohesive, collaborative and proactive group. If the board cannot achieve this in itself, how can it expect the CEO to deliver the same from his or her departments and teams?
  4. The pretence and charades associated with stagnant boards need to be eliminated as a requirement for a healthy, well-functioning unit. The old adage that "cleverness divides, but intelligence unites" is all the more pertinent to boardroom relations which, by necessity, boast a plethora of cleverness. In turn, a transparent and objective board will be met with less obfuscation from the CEO.

Soker says humility, integrity and productivity is the best tone from the top that any organisation can have. These create the deeper thinking that serves as the catalyst for both good governance and management.

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