Directors' duties: Control and understand the flow of management information

In ASIC v Healey (2011) 278 ALR 618 (the "Centro case") the Federal Court found the directors of the Centro Group personally liable for errors in the financial statements of the Group for the financial year ended 30 June 2007.  The directors were in error because they failed to disclose:

ASIC alleged that the directors:

The court found that the directors had breached both of these duties.

The corporate structure of the Centro Group was extremely complex, which meant that the process of preparing annual financial statements for the Group was also very complex. 

The directors argued that the information about the borrowings was "lost" in a very large amount of board papers supplied by management.  The court held that this was no excuse, and that if there was an information overload, more time should have been taken to read and understand it.  The court also held that, although the directors were entitled to rely on others, they could not "substitute reliance upon the advice of management for their own attention and examination of an important matter that falls specifically within the board’s responsibilities as with the reporting obligations" (paragraph 175).

Financial statements paint a picture of a company, and are relied upon by shareholders and potential investors in their decision-making.  The Corporations Act 2001 places upon the board and each director the specific task of approving the financial statements.  In this sense, directors are the last line of defence against errors.  Although directors are entitled to rely on information supplied by management, they cannot blindly accept that information.  In the Centro case, "the directors failed to see the 'obvious errors' because they all took the same approach in relying exclusively upon those processes and advisors.  No director stood back, armed with his own knowledge, and looked at and considered for himself the financial statements" (paragraph 569).

The court did not impose a penalty on the non-executive directors.  However, the CEO was ordered to pay a pecuniary penalty of $30,000 and the CFO was disqualified from acting as a director for two years.  Each defendant was also ordered to pay a portion of ASIC's legal costs.

Tips for directors:

  1. Ensure that the directors control the information flow that management provides by ensuring the information to the board appears in a clear manner and in a way that is easy to comprehend.  Board papers should give the directors a clear picture of what is going on in the company, without overloading them with information.
  2. Ensure that you have the financial literacy to apply critical thought and judgment to the work done and documents presented by management and advisers.
  3. Stand back, armed with your own knowledge of the company, and consider for yourself whether the picture of the company painted by the financial statements concurs with that knowledge.