Thomson's Corporations Law Academic Alert - Issue 1, 2007

Each issue of Academic Alert highlights current corporate issues and explains in simple terms the law relevant to the area. The explanation of the relevant law will enable students to appreciate how the material they are studying relates to current corporate events.

In this Academic Alert we discuss issues relating to the financial services provisions of the Corporations Act, AGM's and issues concerning proxy votes, disqualification of directors and ASIC's role in policing the law, and the role and powers of the Takeovers Panel. These issues are discussed in the context of the following current matters:

1. CORPORATE SOCIAL RESPONSIBILITY
2. TRACKING DOWN THE TRUE OWNERS OF SHARES
3. ARE ASIC'S DIRECTOR DISQUALIFICATION POWERS UNCONSTITUTIONAL?
4. INSIDER TRADING - HANNES APPEAL DISMISSED

Academic Alert will provide a current perspective on corporate issues together with information and explanation that will assist students in relation to some of the matters they will encounter in a course in company law.

Academic Alert is brought to you by Michael Quilter, Macquarie University and Jason Harris, University of New South Wales.

CORPORATE SOCIAL RESPONSIBILITY

As company law develops and regulation becomes more complex in order to respond to the increasing sophistication of the market, the basic propositions upon which the legislation is founded require reassessment. For example the checkered history of establishing national corporate legislation was driven by the maturing of the commercial landscape, in many ways including technological advances and the globalisation of commerce. It is only reasonable then that as commercial, sociological and political change becomes swifter so too will be the legal need to respond. In terms of company law this has meant that amendment to the legislation has been thrown open to less tangible concepts such as the responsibility of directors to both the wider community and the environment. In a general sense the area is described as corporate social responsibility or ethical corporate governance. The issue has gained significant importance as irresponsible corporate management has become more widely targeted. The Corporations and Markets Advisory Committee (CAMAC) issued a lengthy discussion paper on the area in November 2005. The issues are diverse and companies as different as James Hardie Industries and the Australian Wheat Board can be swept into those to which the principles may have relevance. Note that recently (in a memorandum dealing with its arrangements with the NSW Government prepared for a company meeting early next year) the board of James Hardie acknowledged the benefits of corporate social responsibility as concerns employees and stakeholders generally.

As an overall principle good corporate governance should lead to corporate social responsibility. Factors in good corporate governance include ethical and responsible decision making, integrity in financial reporting, timely disclosure and recognition of the interests of stakeholders in the company. It is this last characteristic that is at the core of the expanding need for socially responsible decision making. Whereas directors must of course consider the interests of their shareholders, this in itself is not the entire picture. As corporations grow in size their reach and influence affect more than merely their shareholders. It was the James Hardie employees that suffered firstly as a result of their working conditions (working with asbestos) and secondly, when certain corporate arrangements impacted upon the company's ability to pay compensation as ordered. The AWB matter (discussed in Corporations Law Academic Alert Issue 2, 2006) has been recently resurrected in the media as the Cole Inquiry's findings target several of the company's directors. Basically the AWB through some of its senior management paid bribes to the former regime of Suddam Hussein in Iraq. The findings of the Cole Inquiry used terms such as “thoroughly disreputable” and “no commercial morality” to describe certain conduct of directors. Furthermore the Inquiry found that the conduct “cast a shadow over Australia's reputation”. Clearly here the stakeholders in the company's governance are far removed from merely its shareholders.

Sometimes the mere use of a corporate structure can affect the outcomes for stakeholders. A recent example concerns ABC Learning Ltd (ABC). See Corporations Law Academic Alert Issue 3, 2006 for a discussion of company liability under statute and ABC. Already the largest publicly listed child care provider in the world, ABC is set to expand substantially, increasing its dominance of child care centres in Australia. However concerns have been raised by educational and children-related groups over some time now that the delivery of child care and the corporate ethos may not be a successful mix. Not of course as concerns profit – ABC is in a very strong financial position. The issue revolves around the delivery of results to shareholders (good dividend return and strong share price) and what effect the drive for profit has as far as running and managing a child care centre. If anything, a child care centre is the antithesis of a company. In child care the adding of value is focused on the child – a positive experience and the child is better able to cope with its next challenge – success follows the child, it only finds its way back to the child care centre by word of mouth. A company on the other hand must have something to show for its effort, something that stays with the company – profit.

There is no evidence that ABC is running its operations any differently than it would if it was involved in any other business. The issue that arises is wider than a single instance – it is whether corporate structures will ever be able to really be the “individual” that s.124 of the Corporations Act sets out they are. Where profit and accountability for profit are the cornerstones of endeavour the "legal person" that is a company may be unlikely to deliver its services in the same way as an accountable and involved human and 'as a result' the way certain businesses are run may change. This is not necessarily a bad thing, but as the comments of certain groups involved in the delivery of child care illustrate, it may create concern.

Even though corporatisation of certain industries may change how services are delivered, the ability of the parliament to legislate for, and in response to change, can address balance. The issue of corporate social responsibility is one example. CAMAC's discussion paper reflects the need for companies to widen the range of those whose interests they should consider.

TRACKING DOWN THE TRUE OWNERS OF SHARES

Chapter 6C of the Corporations Act 2001 (Cth) contains a range of provisions that require the owners of shares in listed companies, in certain circumstances, to identify themselves and disclose the extent of their shareholdings. These provisions include:

* Substantial holdings
There is an obligation to disclose the creation, termination, addition or reduction of a “substantial holding” in a listed company (s 671B). A substantial holding is defined in s 9 as having a “relevant interest” (basically control over the voting rights or disposal rights of voting shares) in 5% or more of the votes attaching to shares in a company (note: whilst shares will ordinarily have 1 vote per shares, some companies have differential voting rights spread across different classes of shares). Once a person obtains a substantial holding they must notify the company (s 671B(1), and are also obliged to notify the company once they stop having a substantial holding (i.e. their relevant interests in voting shares drops below 5% of the votes attaching to shares in the company) or if they increase or decrease their holding by 1% or more.

* Beneficial ownership notices
ASIC or a listed company may give notice to a member of the company and require that member to disclose the extent of their “relevant interest” in the shares, and the extent to which any other person has a relevant interest in those shares (ss 672A, 672B). A simple example would be shares held by a trustee on behalf of beneficiaries (eg such as a superannuation trust that invests in shares on behalf of members). Since 1 January 2005, listed companies have been required to keep a register of beneficial owners, which contains information obtained through the disclosure requirements of s 672A.

The policy underpinning these provisions is that the owners of shares in listed companies should be disclosed to the company so that it can keep track of aggregations of its shares (for monitoring potential takeovers for example), bearing in mind that s 606 prohibits the acquisition of relevant interests in excess of 20% of the votes attaching to shares in the company without launching a formal takeover.

The failure to comply with these provisions gives rise to civil liability in the form of compensation that may arise out of damages caused by the failure to give proper disclosure. A breach of the disclosure obligations outlined above may also give rise to fines in excess of $2000 and/or 6 months imprisonment.

In recent times, the former CEO of Gribbles Pathology (a listed medical services company) has been charged with failing to comply with the above requirements by seeking to hide (over a period of 3 years between 2001 -2004) a 43% stake in the company through a complex network of overseas companies and trusts. The shareholdings were highly significant as Gribbles was touted as a potential takeover target (and was bought in a takeover) and the shareholdings would have a significant impact on the success of any takeover (and therefore impact on the market price). The CEO is also charged with various other offences including breach of directors' duties and making misleading statements to the market and will appear in court in April 2007.

Further information may be obtained from the ASIC website:
http://www.asic.gov.au/asic/asic_pub.nsf/byheadline/06-418+Former+Gribbles+CEO+charged?openDocument

ARE ASIC'S DIRECTOR DISQUALIFICATION POWERS UNCONSTITUTIONAL?

The Corporations Act provides several remedies for directors who breach their duties and obligations required under the Act. If a director breaches the duties owed under ss 180-183, 588G, the director may face an action by ASIC to obtain a civil penalty declaration under s 1317E (basically a court order stating that the director breached the statutory duty). The making of a civil penalty declaration then allows ASIC to pursue a pecuniary penalty order under s 1317G (essentially a civil fine up to $200,000) and/or a court order disqualifying the director for a period of time (see Corporations Law Academic Alert 2006 Issue 6 for further discussion).

However, it is not only the court that has the power to disqualify a director. Section 206F of the Corporations Act allows ASIC to disqualify a director for up to 5 years in circumstances where :
• That person was an officer (see s 9 which includes a director within the definition of an officer) of 2 or more corporations that within a period of 7 years entered liquidation during the director's time with the company or within 12 months after the director ceased working for the company; and
• The liquidators of those companies lodged a report with ASIC detailing potential offences by the director or that the creditors of those companies would be unlikely to receive at least 50% repayment of their debts.

In order to disqualify a director under s 206F ASIC may give the director an opportunity to explain why they should not be disqualified. ASIC is obliged under s 206F(2) to take into consideration the director's role in the companies, the relationship (if any) between the companies and whether the disqualification would be in the public interest.

This power of disqualification has recently been applied to Milan Visnic who was banned by ASIC for 5 years for his involvement with 14 failed companies that left debts totalling almost $6 million. Mr Visnic has now appealed that decision in the High Court of Australia on the grounds that s 206F is constitutionally invalid. The argument is that s 206F is a form of judicial power, which cannot be given to an administrative body such as ASIC. This is because the Commonwealth Constitution provides that federal judicial power may only be given to a federal court established under Ch III of the Constitution. As noted above, most of the disqualification powers under Pt 2D.6 of the Corporations Act 2001 (Cth) are given to the court. Section 206F is therefore unusual as it allows ASIC to effectively punish a director by disqualifying them from working as a director (managing a corporation) for up to 5 years. If Mr Visnic succeeds then ASIC will need to take court action either to obtain a criminal conviction (which provides an automatic disqualification under s 206B) or seek a civil penalty declaration (which would allow a disqualification under s 206C). The Visnic case is being heard by the High Court at the same time as several other cases dealing with the constitutional validity of disqualifications of company liquidators by the Companies Auditors and Liquidators Disciplinary Board under s 1292. The cases will be heard in early 2007.

INSIDER TRADING - HANNES APPEAL DISMISSED

On the 24th November 2006 the NSW Court of Criminal Appeal in Hannes v Director of Public Prosecutions (Cth) (No. 2) [2006] NSWCCA 373 dismissed an appeal by Mr Simon Hannes against a conviction recorded against him in 2001 in relation to insider trading pursuant to the then current s.1002G(2) of the Corporations Act (the relevant section is now s.1043A).[Note that as all acts, including the Corporations Act, are amended, content is added or deleted and as a result sections that previously dealt with a particular area may change, change their section number or disappear altogether - sometimes the content remains the same, sometimes it is different]. Mr Hannes was a director of Macquarie Corporate Finance (MCF), a division of Macquarie Bank Ltd during the time that the company advised TNT Limited (TNT) in relation to a friendly takeover by a Dutch company. Approximately two weeks prior to the takeover a large amount of call options in TNT were purchased by Mr Hannes under another name. When the takeover announcement was made public the call options returned a profit of over $2 million. Mr Hannes was not part of the team providing advice to TNT however the prosecution alleged that he had access to the relevant information and made use of it. Mr Hannes was sentenced to a jail term (which has been completed) and fined.

The Court of Appeal in dismissing the appeal considered various aspects of the offence including the width of the definition of "information" (the section at the date of trial was s.1002A - the relevant section today is s.1042A). In essence the Court held that even though the information may be vague or imprecise the source of the information may outweigh the imprecision and take considerable importance. Further it could not be concluded that just because a part of the information was generally available that the information as a whole was generally available. The issue of when information is generally available is dealt with in s.1042C.

At the time of the original hearing of this matter in 1999 and even at the time of Mr Hannes' earlier appeal in 2001 the prosecution of insider trading matters was uncommon and public recognition of the issues involved was low. However since the wide media coverage of the Rene Rivkin matter (R v Rivkin [2003] NSWSC 447) public awareness has grown and ASIC has invested considerable energy into pursuing insiders (see Corporations Law Academic Alert Issue 3, 2006 “Active regulation on show – Citigroup under pressure”). Further evidence of the focus on insider trading can be seen in the recent review conducted by The Sydney Morning Herald examining the frequency of company directors trading in their company's securities just prior to major company announcements. While trading ahead of important announcements does not necessarily mean that the director will be privy to, or use, inside information it does nonetheless increase the risk of this occurring.

Increased media focus and continuing ASIC investigation will ensure insider trading retains its high profile and it is likely that the number of prosecutions will increase as a result. For example ASIC has noted in its media releases that on 28th November 2006, and as a result of its investigations, a former media relations consultant to Aristocrat Leisure Limited, Ms Margot McKay pleaded guilty to three charges of insider trading. Clearly such successes and matters such as the dismissal of Mr Hannes' appeal will provide further incentive for ASIC's campaign to unearth insider trading.

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