What the Centro case means for executives and directors: Bartholomeusz

The Australian Securities and Investments Commission’s civil action against directors, former directors and former executives of the Centro Properties Group could have quite profound implications for boards and their relationships with their executives and their auditors.

The proceedings against six non-executives, past and present, the former chief executive, Andrew Scott, and former chief financial officer Romano Nenna relate to the misclassification of $1.5 billion of borrowings in Centro Properties’ 2007 accounts, and $598.3 million in Centro Retail’s, as non-current liabilities. They were subsequently reclassified as current.

The action is one that is based purely on the responsibility of directors and CFOs to take reasonable steps to ensure that the information in financial reports and market disclosures is accurate and complies with accounting standards.

While it isn’t about holding the board and executives responsible for the effective collapse of the Centro group, the misclassification actually does relate to the key issue which triggered the implosion in the Centro group at the very onset of the financial crisis.

Centro had, in the lead up to the crisis, paid $US6.2 billion for the New Plan property group in the US, funded with short-term debt.

It had both the time and the opportunity to refinance that debt and the funding for other acquisitions it had made in the US, but Scott wasn’t happy with the terms the banks were offering.

He was still haggling with them when the crisis erupted, leaving Centro Properties with more than $2.5 billion of maturing borrowings that couldn’t be refinanced and therefore in the hands of banks that were themselves in crisis.

It is significant that ASIC makes a special point of saying that the case against the Centro board and executives is the first brought where an issue for the court will be the requirement that a listed entity’s CEO and CFO declare in writing to the company’s directors that financial reports comply with accounting standards. That requirement came out of the response to the Sarbanes-Oxley reforms in the US after the tech-wreck in 2001.

The Centro group accounts in question were signed by former chairman Brian Healey and Scott on September 6, 2007. The auditors, PricewaterhouseCoopers, also signed off on their own opinion that the accounts complied with the accounting standards on that same day.

There is no suggestion at this stage that the Centro directors knew of the misclassification when they approved the accounts, which means that the core question for the court is whether they should have known.

That’s a complex issue which goes to the heart of the governance of companies generally, to the nature of the relationships between board and management and to the degree to which boards can place reliance on the information provided to them by management and the assurances given by auditors.

It has to be remembered that until the crisis, and that fatal decision not to refinance when funding was still available, Centro had been remarkably successful. Scott had built the group from a one-property $100 million trust in 1991 into the second largest retail property group in Australia and fifth-largest in the US, with more than 700 centres.

The Centro structure was extremely complex and leveraged and had ridden what ultimately turned out to be a credit bubble, but until the worst financial crisis in 70 years emerged, the board had no reason to distrust Scott or his management.

The Corporations Act provides a defence for directors if they have relied on information from employees or professional expert advice if that reliance is in good faith and they have made an independent assessment of the information and the reliance is reasonable – having regard to the directors’ knowledge of the corporation and the complexity of its structure and operations.

Presented with a signed declaration from their CEO and CFO that the accounts complied with accounting standards, and a sign-off from their auditor, at a time when the business appeared to be prospering and external conditions were balmy, could the non-executive be reasonably expected to question the validity of the accounts? Should they effectively have conducted their own independent audit of the accounts? Why require the declaration if it can’t be relied on?

That is a question that has wide significance for the way companies operate. Should the natural relationship between boards and managements – and even auditors – be one underpinned by suspicion and skepticism and, if effect, be adversarial?

Could companies function if there were that degree of separation between non-executives and executives and that degree of tension in their relationships?

The boards of Centro Properties and Centro Retail disclosed the misclassifications in January last year. A month later they were still reviewing the circumstances surrounding them, which suggests that they were anything but straightforward.

The detail of what occurred, or didn’t, will no doubt emerge in the course of ASIC’s action as well in the two class actions that are also underway.

The James Hardie case may have made directors very wary about the detail of press releases. The Centro case will be watched intensely by the corporate sector because it has far wider implications for the day-to-day governance of companies and the potential liabilities that might proliferate if boards aren’t able to rely on declarations from their CEOs, CFOs and auditors.

This article first appeared on Business Spectator.