A beginners blog of corporate governance and corporate and securities regulation

What is good corporate governance?

2011-08-08T11:02:00.004+10:00

What is good corporate governance?
Corporate governance is the system by which corporations are directed and controlled:

The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as, the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.

The subject of corporate governance is wide and varied. Even though good corporate governance can mean different things to different people, essentially it is an extended partnership between a company and a range of other groups including its shareholders, its management, its employees, the regulators, the markets and the wider community. It also regulates the relationship between a company's members.

Good corporate governance is at least:
o a system of checks and balances to promote fairness, accountability and transparency;
o part of an overall risk management program;
o founded on the premise that the board is charged with the role of agent for the shareholders to ensure the organisation is managed in the shareholder's best interests;
o about protecting the organisation's reputation; and
o capable of responding to the tension between ensuring managerial accountability and enhancing per-formance.

Good corporate governance is applicable to public, private, government and not-for profit organisations alike.

Good governance and good risk management have many similar features. Both identify and determine the amount of acceptable risk; establish a regime to measure and monitor risk, separate risk management from management; and develop a strong corporate risk culture so that the rewards, as well as the risks, are always considered.

Responsibility for corporate governance commonly falls on the board. Any governance standard adopted by a board is likely to be used as a benchmark in assessing whether a board or individual directors have applied a reasonable degree of care and diligence in exercising their powers and discharging their duties, as is required by law. One key element of the governance of a corporation is its constitution, the relationship between the governance matters and the constitution is a very interesting area and one I plan to wite on further: see The 2010 McPherson Lectures Series by Dr Robert P Austin, Adjunct Professor and Challis Lecturer in Corporate Law, the University of Sydney (formerly a Judge of the Supreme Court of New South Wales - three one-hour lectures in the Series under the topic, 'The Role and Duties of Australian Company Directors: a Restatement'.

In Australia there are many sources of corporate governance rules, including the Corporations Act 2001, common law and the company's constitution. The Australian Standards, "Good Governance Principles", and the ASX Corporate Govern-ance Council's Principles and Recommendations also provide a sound approach to corporate governance for many different types of entities.

The area of corporate governance on the whole is premised on self-regulation. Self-regulation is flexible, able to evolve to meet specific and changing circumstances, utilises the expertise of those it regulates and has the ability to enlist the support and input of stakeholders within the industry to create an effective culture of performance.

A beginners blog of governance, corporate and securities stuff: Photo

2011-08-08T11:02:00.001+10:00

A beginners blog of governance, corporate and securities stuff: Photo

Centro decision

2011-08-08T09:38:00.002+10:00

I think there is an interesting question emerging for directors and officer from the decision in Centro.

What is the nature of the "certification" obligations? Is 295(4), 344(1) different from other Corporations Act requirements?

How does this impact on takeover documents, prospectuses etc. What are the effective limitations of "reasonable reliance"?

It seems that as regards the accounts they could not delegate or "abdicate" that responsibility to others. Middleton J said that:
…directors cannot 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.

In Middleton J's view:
the whole purpose of the directors’ involvement in the adoption and approval of the accounts is to have the directors involved in the process at a level and responsibility commensurate with their role.

In other words, a reasonable step would be to delegate various tasks to others, but this does not discharge the entire obligation upon the directors.

A further step is required, which involves the directors taking upon themselves the responsibility of reading and understanding the financial statements in light of an understanding of basic accounting concepts.

The same reasoning applied in respect of reliance by directors on the audit committee. Middleton J held that whilst an audit committee has an important role in monitoring and oversight, this cannot be to the exclusion of the role of a director to consider the financial accounts.

The “national interest test” and Australian foreign investment laws

2011-05-27T13:35:00.002+10:00

Introduction

The national interest test is by its nature opaque. The decision of the Treasure to publish his reasons is a welcome trend.

Published reasons ought to be encouraged in all major FIRB approvals and rejections.
The availability of reasons will lead to an overall better system one less likely to be criticised as being “a “protectionist relic” that does not fit with the Australian Government’s free markets principles”. The national interest test has always been an opaque standard. The test was introduced in 1986. It was intended to reflect a changed bias towards foreign investment but it has been the subject of substantial criticism.

In a sense, the test is both a strength and the weakness of Australia foreign investment policy. The recent decision by the Treasurer to reject the takeover of ASX Limited by the Singapore Exchange emphasises many the test including the difficulty of pinning down what exactly is “the national interest”.

The decision of the Treasurer to publish his reasons is an unusual but welcome step towards transparency in the FIRB process.

Background
Australia is a subscriber to the OECD Declaration on International Investment and Multinational Enterprises. Australia’s regulatory regime sits in the mid-point of OECD countries in terms of its relative level of restrictiveness. Australia’s score is held back by the fact that the national interest test is seen as a “discriminatory screening requirement”. Even though the onus of proof that a foreign investment proposal is “contrary to the national Interest” rests with the Government and not with the investor. Indeed the OECD’s annual Going for Growth found that screening might create uncertainties that limit foreign direct investment. Indeed the review suggested that: Transparency would be enhanced by more information on the criteria applied in government decisions and by involving specialist agencies (e.g. national securities) in the review process of FDI approval.

Australia’s investment policy is decidedly pro-investment. Australia rarely invokes the national interest test to reject foreign investments.

In the case of the ASX SGX deal one inherent problem was that the transaction was never seen as a merger of equals. It was always characterised as an SGX takeover. In this sense no matter what concessions were made, there were deep seated concerns that the deal would not give ASX a sufficient voice. This point is expressly acknowledged in the Treasurer’s reasons:
To diminish Australia's economic and regulatory sovereignty over the ASX could only be justified if there were very substantial benefits for our nation, such as greatly enhanced opportunities for Australian businesses and investors to access capital markets. Given the size and nature of the SGX –which is a smaller exchange with a smaller equities market than the ASX – the opportunities that were offered under the proposal were clearly not sufficient to justify this loss of sovereignty.

The Government and FIRB have consistently been reluctant to approve foreign acquisitions which might result in parties who have lower levels of interest in developing Australian assets ahead of other global interests. In the case of Woodside Petroleum in 2011 there were substantial concerns that the proposed new owners (Royal Dutch Shell) would not have an interest in developing the Australian asset ahead of their other global assets. Again the Treasurer’s reasons point to this feature:
It is in the national interest for Australia to maintain the ongoing strength and stability of our financial system, and ensure it is well placed to support the Australian economy into the future. It is important that we continue to build Australia's standing as a global financial services centre in Asia to take best advantage of the benefits of our superannuation savings system. I had strong concerns that the proposed acquisition would be contrary to these objectives.

While there have been calls for the national interest test to be more precisely defined and to replace the role of the Treasurer with an independent body that would not achieve the same functional purpose as is provided by the existing test. What is then the existing test and how is it applied?

So what is Australia’s national interest?
In many respects the national interest is “a bit like an elephant”. Hard to describe but you know one when you see one. As Ashton Calvert commented in 2003 “The Australian national interest is something that is defined by the Australian Government and the Australian people. It is not static and cannot be defined in a mechanical way.”

The legislation does not provide a mechanical definition or guidelines against which to measure the national Interest. FIRB as the advisory body to the Treasure is not obliged to reveal either how it arrived at a decision or what is its recommendation to the Treasurer that is entirely consistent with usual general principles of advice from Treasury to its minister. The Treasurer is not compelled to provide justification or clarification as for the reasons for his or her decision. This has resulted in accusations of political expediency and of failing tests of transparency and openness that no one would expect in a democracy like Australia.

In the case of the SGX merger it is helpful that the Treasurer has provided insight into his thinking in prohibiting the acquisition of ASX by SGX. In March 2009 the Treasurer issued statements in connection with the Oz Minerals Ltd and has issued details of conditions attaching to transactions but he has not previously issued formal reasons.

The National Interest includes the following:
* preserving of national security;
* preserving of Government revenue;
* evidence that the participant will respect Australian law and business practices;
* avoiding of inappropriate levels of competition or excessive concentration;
* consistency with Government policies; and
* the character of the investor.

Of these, the most ambiguous is the national security test. This test has on occasions been applied to prohibit acquirers from purchasing mining assets that were considered to close to the Woomera prohibited area and in the SGX transaction it is being considered by reference to the systemic security of the Australian Financial System.

That said that the Treasurer’s decision took in to account the “importance of maintaining the effectiveness of Australia’s regulatory framework and the Government’s objective of building Australia’s standing as a regional financial services centre.”

Apparently the decision was also based on “the importance to Australia and its long term economic well being of the development of the ASX as primary equities and derivatives exchange and sole clearing house.”

There is no doubt that the Treasurer formed the view that the role that ASX played in the Australian financial system was such that the takeover by SGX may have meant a loss of “full regulatory sovereignty” that might have a negative effect on Australian regulatory authorities capacity to protect the system from financial crisis.

The ASX also operates infrastructure that is critically important for the orderly and stable operation of Australia's capital markets. Both the Reserve Bank of Australia (RBA) and the Australian Securities and Investments Commission (ASIC), carefully review the operations of the ASX on an ongoing basis and have been satisfied that it is meeting its obligations and remains a robust operation. However, FIRB's recommendation, which incorporated advice from ASIC, the RBA and the Australian Treasury, was that not having full regulatory sovereignty over the ASX-SGX holding company would present material risks and supervisory issues impacting on the effective regulation of the ASX's operations, particularly it’s clearing and settlement functions. Australia's financial regulators have advised me that reforms to strengthen our regulatory framework should be a condition of any foreign ownership of the ASX to remove these risks.

This analysis is not surprising. The Australian clearing and settlement system has been the subject of a number of enquiries following the global financial crisis including the Review of Settlement Practices for Australian Equities in May 2008.

The Treasurer found that the clearing and settlement system operated by ASX was critical to the smooth functioning of the Australian financial system. FIRB advised him that there was a genuine concern that the wider role of Government as a regulator meant that he ought to be careful before he agreed to give up flexibility over the market mechanism. In part is an acknowledgement that the rules are never going to be perfect and they do not necessarily anticipate all the consequences or “externalities” that may arise.

The Treasure asked the Council of Financial Regulators to establish a working group to consider measures which to protecting the interests of Australian issuers, investors and market participants. Clearly there was a perceived need to preserve the ability of our financial supervisors to maintain “robust oversight in all market conditions, including in the event of a future commercial arrangement between the ASX and another exchange”.

Conclusion
In 2005 the Financial Times described the national interest test as a “protectionist relic” that does not fit with the Australian government’s free markets principles. The Times argued that screening foreign investments was common among countries but the few countries “operate regimes that are more opaque, unaccountable or open to political and bureaucratic manipulation”.

While some of the criticism meted out by The Times is warranted this ought not to be a reason to abandon the test. The test serves a useful function for the Government as a macro economic regulator of the economy.

The Government ought to retain the flexibility to be able to deal with the consequences or externalities that may arise from the foreign takeover. That said, as noted by the OECD there is great merit in greater transparency around the process and this would be enhanced by a regular process of providing detailed decisions by which others could judge how the process operated.

Corporate lenders – a new focus for insider trading?

2006-12-06T18:10:00.000+11:00

The Australian Securities and Investments Commission's enthusiasm for insider trading cases and the difficulties of managing Chinese walls ought to give hedge and private equity fund managers pause. In the United States the growth of activity by private equity and hedge funds in the debt and quasi-equity market has resulted in the Securities Exchange Commission reviewing one situation and it's unlikely to be unique.

Like the SEC, it is likely that ASIC will be closely watching private equity and hedge funds. These funds have become active lenders in the Australian market, offering alternative sources of debt and quasi-debt funding to companies such as Advance Healthcare Group Limited, Nylex Limited and PBL Media. Often, the debt will be structured to provide a yield as well as an opportunity to participate in increased equity value via the ability to convert debt into shares.

Apart from the funding structure itself, one of the key differences between being a debt provider and being a shareholder is the level of information the borrower is required to provide. Typically, a lender will receive more frequent and more detailed financial information than anyone outside of the key management team. Generally, this information will be material and price sensitive.

Of course, being in possession of inside information is not of itself a problem. The difficulty arises when someone with inside information deals in those securities. Where lenders who possess inside information are also in the business of trading the debt or trading the company’s securities, or where the debt instrument itself can be converted into securities, the potential for trading on the basis of inside information is significantly increased.

In the case of the US movie rental chain company, Movie Gallery it is currently receiving attention by the SEC. In early March of this year, Movie Gallery held a private conference call with its lenders, most of whom were hedge funds, to discuss the company’s poor results for 2005. Over the 2 day period following the call, Movie Gallery’s shares were heavily traded and its share price fell by 25%. However, the company didn’t announce its earnings results to the public until nearly two weeks after the private call with its lenders. The SEC is now investigating whether any of the lenders traded on the basis of their inside knowledge of the company’s poor trading results.

If there are Chinese walls in place a fund will not breach the insider trading rules merely because one of its employees has inside information and another employee trades. What they need to establish is that the person with inside information is not involved in trading decisions and there are adequate arrangements in place to ensure that inside information is not communicated to those who are and that therefore no benefit has been unfairly obtained by having the inside information.

The critical question is how effective are the Chinese walls? Do they really prevent the inappropriate use of inside information? To have any effect the arrangements need to be established with clear protocols and those protocols must adhered to and monitored. There needs to be a clear separation between those who possess or have access to inside information and those who make trading decisions.

While it may be possible to implement such arrangements within large organisations that can physically separate different work groups, clearly this is much more difficult to achieve for organisations operating with small teams, as is often the case with private equity/hedge funds.

Even where Chinese walls can be established, they do not provide absolute protection from liability. It is virtually impossible to prevent staff members from coming into contact with each other and potentially communicating inside information. If you possess inside information at the time of making a transaction, it is no defence to say that you did not use or rely on that information at the time.

For the majority of private equity/hedge funds, the ‘pared back’ styles of doing business will create a real problem when they need to show effective Chinese walls. A two person team sitting next to each other are never going to be effectively separated by a wall, let alone a Chinese wall.

Take me to the limit one more time: how far do disclosure obligations go?

2006-05-31T08:53:00.000+10:00

The recent leak of New Zealand cabinet papers to Telecom NZ and the now infamous CD-ROM found in a Qantas lounge raise interesting questions about the limits of the obligation to disclose under ASX Listing Rule 3.1.

Are companies bound to disclose all materially price sensitive information irrespective of how it’s obtained? On its face the only relevant test is whether a reasonable person would expect to have a material effect on the company’s share price.

We normally expect that information that is disclosed to the market is produced according to the highest standards to ensure we have a fair and well-informed market. But are there circumstances where information that is defamatory, illegal or obtained in breach of confidence must be disclosed to the market?

To avoid the disclosure requirement, the information must meet three criteria. Firstly, a reasonable person would not expect the information to be disclosed. Secondly, the information is confidential. Thirdly, one of the following criteria apply: it would be a breach of a law to disclose the information or the information concerns an incomplete proposal or negotiation, the information is insufficiently definite, generated for internal management or the information is a trade secret.
But what if the information fits the first and third criteria, but is not considered confidential under the Listing Rule?

In the ASX’s view ‘confidential’ is a matter of fact. For example, confidentiality is retained when information is given to third parties in the ordinary course of business, but is lost once, whether inadvertently or deliberately, the information becomes known by others, in circumstances where the company loses control of the information (the recipient is not under an obligation to keep the information confidential). An example is a rumour circulating or media comment about the information where that rumour or comment is “reasonably specific.”

In a submission to ASX in 2002, The Australian Institute of Company Directors’ questioned the suitability of ASX to determine confidentiality as a fact, and stated that this should be a matter for the company to determine, after taking advice where necessary.

Of course this is not how the law would generally look at the question of confidential information. A lawyer will tell you that confidentiality is largely a question of the nature of the information and how it is obtained, largely regardless of whether it is known to others.

So, on the one hand ASX Listing Rule 3.1 states that information known by others over which the company has no control is not confidential. On the other hand, under the general law where confidential information has been knowingly obtained in breach of confidence the information remains confidential, even if it has been disclosed by the recipient. So clearly ASX Listing Rule 3.1 and the general law doctrine of confidential information cannot be easily reconciled.

The problem of ASX’s interpretation of confidential information being different to that under the general law is that there are serious consequences under the Corporations Act for failure to comply with the ASX disclosure obligations.
A listed company receiving significant material even illegally or improperly is faced with a dilemma, as no doubt the cabinet paper proved to be to the board of Telecom NZ. Either breach the disclosure rules or be sued or possible prosecuted; a rock and a very hard place!

It would seem the existing listing rules left as is create a strange situation where information illegally or improperly obtained, which by its nature cannot be verified to ensure its accuracy, must be disclosed to ensure a ‘fair and well-informed market’.

Thanks to Belinda Coombs for her assistance with this piece.

Remuneration committees - “in the line of fire”

2006-05-05T08:36:00.000+10:00

Corporate Social Responsibility: the case for a self regulatory model

2006-05-05T08:30:00.000+10:00

The limited liability corporation is one of the greatest inventions of all time. The corporation is an integral part of our society yet it would seem that society is raising some pretty challenging questions about the role of the corporation in our society. Is there is a need to find a way to enable corporate managers to abandon rules designed in the 1800’s in favour of a more modern concept that recognises the wider role of corporations in our community?

Recently, the Parliamentary Secretary to the Commonwealth Treasurer, the Hon Chris Pearce MP, referred the question of corporate social responsibility to the Corporations and Markets Advisory Committee for consideration and advice. Reflecting these concerns, the Australian Financial Review has editorialised that: “Modern capitalism has many strengths but one big weakness. Some executives are so driven to achieve legitimate corporate goals bigger profits, more shareholder value, a critical restructuring that they are able to justify any technically legal means of pursuing them. The risk is that management and board lose sight of a fundamental question: is this just? In the vast majority of cases their duty to the company and the law is not in conflict with any wider duty, and society as a whole benefits from the wealth created. In rare cases, what is legal and what is just are at such odds that strict legal justifications crumble before community outrage and the threat of legislative action.

In part this is a response the report the Special Commission of Inquiry into the circumstance surrounding James Hardie’s corporate reconstruction. Interestingly, in March 2005, James Hardie’s chair, Meredith Hellicar, called for: “a safe harbour for directors to be able to integrate corporate social responsibility into their decision making without fear that they are going to be sued both personally, and as a company, by their shareholders. “.

To what extent is this concern real? Does Australian corporate regulation need to reflect ‘modern business needs and wider expectations of responsible business behaviour’, that ‘the basic goal for directors should be the success of the company for the benefit of its members as a whole’ and that to reach this goal, directors should be able to ‘take a properly balanced view of the implications of decisions over time and foster effective relationships with employees, customers and suppliers, and in the community more widely’?

There is advantage in providing a reasonable level of protection for those that want to take the ‘long view’. However, many commentators believe that the existing duties of managers, especially the overriding duty to act in the best interests of the company, already accommodate consideration of wider interests by directors and officers if the decision is justifiable as being in the company’s best interests.

Yet, it seems that managers have concerns about how to take a properly balanced view of the implications of their decisions as well as foster effective relationships with employees, customers and suppliers, and the community more widely, whilst at the same time not leave themselves open to complaint from shareholders.

The increased community calls for some form of corporate social responsibility cannot simply be ignored; these are the ‘cultural norms’ that shape the way corporations are allowed to operate. In Canada a significant number of Canadians, and a significant percentage of Canadian shareholders, have been found to want business executives of corporations "to take into account the impact their decisions have on employees, local communities and the country as well as making profit," but can they do so if it at the expense of making profit?

To simply introduce provisions such as those suggested in the UK could lead to greater uncertainty and more capacity for people with only a tangential interest in the company to sue mangers for failing to sufficiently consider their interest or more likely the interests they purport to represent.

The question of whether such a provision is strictly necessary can be avoided by simply including a replaceable rule that will give managers some comfort if they prefer the long view over the short.

The use of a default provision of the constitution giving the managers the freedom to include matters such as employees, customers and suppliers, and the community as being in the interest of the company should provide managers with some comfort.
TIME FOR THE CORPORATIONS ACT TO INCLUDE A NEW REPLACEABLE RULE?
Self regulation is appropriate for complex and difficult issues like corporate social responsibility that do not necessarily require an industry wide solution. A self regulatory model allows a solution tailored to each entity’s circumstances. If there was genuine community agreement about the value of corporate ethics then such provisions affirming their place in the life of the company would quickly gain acceptance as best practice.

Is it necessary for corporate social responsibility to be enforceable? Probably not, as calls for corporate social responsibility have largely been along the lines of the need for a permissive model so, to this extent then there would seem to be no basis for criticising a self-regulation model on the basis of enforcement difficulties.

A self regulatory model will also ensure that only those companies with a genuine interest/need take the issue forward and this is less likely to result in an approach to corporate social responsibility that is a process focussed “tick the box” approach.

A replaceable rule also provides flexibility providing scope for efficiency improvements and innovation. Additionally, such a rule would recognise that many small and micro businesses use the corporate form and do not have the resources to comply with a prescriptive set of rules.

The corporation is create of statute designed for investors to collect together for a common business pursuit through a legal entity that provided the benefits of limited liability, continuity of existence and simplicity in contractual dealings. As part of the bargain, investors should be able to regulate the general nature of their bargain with the other investors and management through the constitution.

The Corporations Act provisions dealing with the constitution could have a default setting that provided that in the absence of an alternative provision in the constitution of a company the board as the agent of the investors were entitled have regard to their a social responsibility the board would be entitled to do more than adhere to the rules and doing “whatever you can get away with”.

The provision would thus form part of the contract between the members and management and it would be theirs to consider, modify if necessary and reject if they wished. It would not be open to regulators, “stakeholders” or anyone who was not a member or officer to enforce against mangers.

A replaceable rule would also lessen the risk of litigation against the corporation by tangential ‘stakeholders’. A statutory proscription to consider social issues, could mean that section 1324 of the Corporations Act could be used to enable the “stakeholders” to seek remedies against managers for not having, say, proper regard to “the community and the environment”. Whilst little use has been made of this provision in developing the view that officers might owe duties to others in addition to their company that is not to say it could not be. The future battle ground for lawyers looking for ways of representing people like the landholders surrounding the BHP mine in Papua New Guinea, Ok Tedi, might be based around the injunction and corporate social responsibility provisions.

In practice, a constitutional provision of this type would not fundamentally alter the circumstances where a board had somehow failed to properly consider, corporate social responsibility type matters in circumstances where it would have been in the best interests of the company to do so. Those directors would still be liable for failing to satisfy their duty of care and diligence. However, if the directors had taken a decision favouring the long term sustainability of the company which resulted in financial detriment to the current shareholders the directors could argue the existence of the replaceable rule was a relevant factor in determining the ‘corporation’s circumstance’ or the office held and the ‘responsibilities within the in the corporation’.

A replaceable rule would also be consistent with the Principle 10 of the ASX recommendations. Compliance with this recommendation was originally contemplated by a code of conduct but a replaceable rule would be entirely consistent with the recommendation. A replaceable rule would also give managers more certainty than a code of conduct, in terms of their duties to the company and the availability of business judgement defences.

An interesting related development might include combining accreditation and self-regulation. A voluntary accreditation scheme might also be adopted to try to ensure consistencies in corporate social responsibility standards across different sectors. Self-regulation of the type discussed could mean that companies are defining their own corporate social responsibility standards and therefore some entities will be taking on far greater corporate social responsibility obligations than other entities.

As with other corporate governance reforms, a self regulatory approach to corporate social responsibility is the surest way to get meaningful approach to this issue. There is a case for reforming directors and officers’ duties; the changes needed should not be revolutionary. A self regulatory model together with a scheme for accreditation provides a better model for influencing behaviour by institutionalising a change that is permissive and reflective of each company’s own circumstances.

If the social norm has shifted, and there is ample evidence it has, then that pressure can be accommodated in the proposed model. The self regulatory model suggested will allow company’s to create wealth on a sustainable basis, but subject to the requirements of responsible business conduct.

Sources: Letter of referral by The Hon Chris Pearce MP to CAMAC, available at http://www.camac.gov.au/CAMAC/camac.nsf/byHeadline/Whats+NewDirectors%27+duties+and+corporate+social+responsibility?openDocument; Parliamentary inquiry into Corporate Responsibility, see online at http://www.aph.gov.au/Senate/committee/corporations_ctte/corporate_responsibility/index.htm; AFR article 22 September 2004, pg 62; UK White Paper on Modernising Company Law available on the UK Department of Trade and Industry's website at http://www.dti.gov.uk/cld/WhitePaper.htm; James McConvill “Directors’ duties to stakeholders: A reform proposal based on three false assumptions” (2005) 18 Australian Journal of Corporate Law 88, see also - Ian Ramsay, ‘Pushing the Limit for Directors’, The Australian Financial Review, 5 April 2005, 63; R. Baxt, “Directors’ Duty of Care and the New Business Judgment Rule in the 21st Century Environment”, Seminar Paper, Seminar on Key Developments in Corporate Law & Equity, Melbourne, March 2001 cited in Saul Fridman “Corporations Law in the courts and the academy: a dangerous malaise?” Butterworths Corporation Law Bulletin No 23 December 1996; ASX Principles of Good Corporate Governance and Best Practice Recommendations.

What’s a banning order worth?

2006-05-04T18:01:00.000+10:00

Rodney Adler, Ray Williams and now Steve Vizard have joined the some 90 company directors and officers banned last year from managing corporations for a variety of periods. But what does it mean to say someone is disqualified from managing a company and how is it policed?
Given the complexities of the commercial environment and the necessary difficulties and delays involved in criminal prosecutions, there is a good case for ASIC having a wide range of prosecution options available to it to resolve matters. Indeed, it is the need for a wider range of enforcement options that has led to the Trade Practices Act being amended so that the ACCC can apply to the court for similar disqualifying orders.
In practice, the banning order is a relatively soft option; the banned person can still provide consulting services to companies, trade as an individual or a partnership, be excused from their banning order and hide relatively easily from a regulator that must find it difficult to monitor every banned individual. However, for former directors of public companies and high profile individuals like Mr Vizard, the reality is that the effect of the order is such that they are unlikely to ever again hold a directorship of a public company or hold any public office. It is really more akin the old public stocks than a protective order. In Mr Vizard's case, it is inconceivable that any company or government would ever again consider his appointment, he has had his public humiliation, is that enough?
WHAT IS MANAGING A CORPORATION?
The banning provisions are intended to cover a wide range of activities relating to the management of a company, each requiring an involvement of some kind in the decision-making processes.
A person who is disqualified from managing corporations commits an offence if they:
 make, or participate in making, decisions that affect the business of the corporation;
 exercise the capacity to significantly affect the corporation's financial standing; or
 communicate instructions or wishes to the directors of the corporation:
– knowing that the directors are accustomed to act in accordance with the person's instructions or wishes; or
– intending that the directors will act in accordance with those instructions or wishes.
Managing therefore requires activities involving some responsibility, but not necessarily control. Advice given to management, participation in its decision-making processes, or execution of its decisions going beyond the mere carrying out of directions will trigger non-compliance as will conveying of instructions for a particular company to sell or acquire an asset, call up a loan or commence proceedings.
In Nilant v Shenton [2001] WASCA 421 referring to Commissioner for Corporate Affairs v Bracht (1989) 7 ACLC 40, Ormiston J was dealing with a matter which fell within s 227(1) of the Companies (Victoria) Code. His Honour said at 49:
In the present section I would see the prohibition as covering a wide range of activities relating to the management of a corporation, each requiring an involvement of some kind in the decision-making processes of that corporation. That involvement must be more than passing, and certainly not of a kind where merely clerical or administrative acts are performed. It requires activities involving some responsibility, but not necessarily of an ultimate kind whereby control is exercised.
Advice given to management, participation in its decision-making processes, and execution of its decisions going beyond the mere carrying out of directions as an employee, would suffice. If the respondent had been left to negotiate terms with bankers or providers of credit, although those terms had to be confirmed, there would have been sufficient participation, but not if those acts involved only communication or were merely casual. The negotiation of matters of financial importance, such as the rent of its principal premises, may well lead to an inference that a person is concerned in the management of a company, but not if that involved merely communication of instructions on a single occasion…
The existence of a board or similar will not of itself be enough to hide the banned individual unless there is some evidence that the directors gave instructions to individual or questioned the decisions or authority to make them.
Acting as a “professional corporate advisor” while the corporation remains reliant on advice and assistance from the banned individual has in the past been found to be “no more than an artifice to avoid the consequences of his disqualification”.
Similarly, acting as a “consultant” where in fact the person had carriage of a matter and is able to deal with suppliers and act with authority to bind the company and make finance arrangements on behalf of the company would breach the prohibition.
Clearly, management of a company can take place at various levels. It is not confined to matters performed by the directors nor limited to formulation of policy and direction of the company. The key is that there must be the exercise of some decision-making power. At the end of the day, the court will generally make a determination based on the overall impression rather than engaging in a minute assessment of each activity.
WHAT ARE THE LIMITS?
A banning order for a breach of directors’ duties is limited. It doesn't apply to trusts nor partnerships, just corporations operating in Australia. It doesn't shut an offender down in a business sense. A disqualified director could feasibly take over the company’s business and operate it as a sole trader.
A person who is disqualified from managing corporations may apply to the court for permission to manage a corporation. The past conduct of the director is relevant to the exercise of the discretions which the law confers on ASIC and the court; they in turn must consider whether there has been a breach of the standards of commercial morality, whether there has been recklessness, whether there has been gross incompetence and whether the public interest requires that the person concerned should not take part in the management of a company.
PROTECTIVE V PUNITIVE
The purpose of banning orders is said to be protective and not punitive, although the courts do recognise that the provisions have some deterrent function. Indeed, the court has observed that the policy is “to protect the public and to prevent the corporate structure from being used to the financial detriment of investors, shareholders, creditors and persons dealing with the company. In its operation it is calculated to act as a safeguard against the corporate structure being used by individuals in a manner which is contrary to proper commercial standards”.
In the Rodney Adler case, Mr Adler’s counsel argued that the protective purpose could be achieved if he was still allowed to be involved in the management of private, family corporations. The Court rejected this submission:
Here, concededly, Mr Adler will be impeded in his field of activity, which includes financial consultancy and investment, including joint ventures, but that is the very area where he has committed the relevant contraventions. That puts in stark relief the need to make the public protective purpose paramount over Mr Adler’s private interests …. To the extent that Adler Corporation and its wholly-owned subsidiaries are already engaged in ongoing financial or business activity, should a disqualification order be made against Mr Adler he will simply have to find others to carry on that activity or manage it, independently of him, on the basis that he must, in the public interest, be excluded wholly from that activity. That is, at least until such time as a court is persuaded to grant leave pursuant to s 206G, if it be so persuaded in light of the then known fact.
A good example of the mixed approach of courts to the protective v punitive issue is the approach of Bryson J in approving the orders agreed with Brad Keeling.
Among the matters the judge thought relevant were Brad Keeling’s age and stage of career at which disqualification would fall, the office held, the extent of his responsibilities in terms of the value of assets, the complexity of the activities and the number of people within the range of adverse effects of his breaches of duty. Clearly, these are issues that go more to punishment than protecting the public and to preventing “the corporate structure from being used to the financial detriment of investors, shareholders…”
In Rich & another v Australian Securities and Investments Commission (2004) 50 ACSR 242 McHugh J at 259 commented on this issue as follows:
It is difficult to read these passages without concluding that there is little difference in the approach of his Honour and the approach of judges making orders or imposing sentences in the criminal jurisdiction. It is hard to escape the conclusion that, in determining the period of disqualification, the courts consider that the larger the loss the longer the period of disqualification that is justified. If that is so, and I think that it is, it indicates that retribution is as much a factor as protection of the public. There is no a priori reason why the protection of the public requires a person who is responsible for the loss of $100m to be disqualified for a longer period than a person who is responsible for the loss of $100,000. The person responsible for the smaller loss may be a far greater danger to the public than the person responsible for the larger loss. Yet, given the approach of the courts, if other things are equal, the person responsible for the major loss will almost certainly receive a far longer period of disqualification.
EFFECT ON REPUTATION
Whilst Rodney Adler received a 20-year ban and Ray Williams a 10-year ban for civil breaches of their duties as directors of the failed insurer HIH, in one sense, the length of these bans is irrelevant. In Mr Vizard’s case:
The reality is that whether it was five, ten or 20 years, Vizard is unlikely to ever again hold a directorship of a public company, or hold any public office. He has demonstrated that he is untrustworthy and unfit to hold such office.
It's inconceivable that any board, or government would consider his appointment, even after he had served out his 10-year ban.
Similarly:
A ten-year ban does not stop [Vizard] from being a consultant to The Communicate Trust and its sprawling empire of media, marketing, advertising, television and PR firms which have paid Vizard plenty over the past couple of years. However, the big question is whether major corporate clients … will continue to deal with The Communicate Trust…
ENFORCEMENT
ASIC keeps a register of persons who have been disqualified from managing corporations or prohibited from managing a corporation.
Over the years ASIC has obtained orders against people like Maxwell John Reid, who was disqualified from managing corporations, stopping them from acting in any way that breaches their orders. ASIC also obtained orders restraining other parties from engaging in any conduct that amounts to aiding, abetting, counselling, or procuring Mr Reid from managing corporations while disqualified.
ASIC has had a pretty rigorous policy of enforcing these types of orders:
 In May 2004, Ms Suzanne Frugtniet was convicted and fined $5000 and ordered to complete a 200-hour community service order after managing Travel Action Pty Ltd, whilst disqualified.
 In November 2003, two company directors Mr David Christopher Novak and Ms Patricia Ellen Kenna were given a three-year good behaviour bond and penalties after pleading guilty to managing a corporation whilst disqualified.
 In April this year, Mr Stephen John Riddell was convicted of a similar offence.
In addition to referring cases in relation to bankrupts managing corporations there is no evidence that ASIC has a program to ensure that banned directors do not manage corporations. Without an active follow up program, what’s a banning order worth? Not much if you don’t fear time in the pillory.
CONCLUSION
The concept of "managing the company" involves terms quite well known … a person is managing a company if they are in any way concerned in its management, or takes part in its management, and this is so, whether the person acts directly or indirectly.
The wide arrange of offences, individuals and circumstances mean that regulators need a large number of enforcement options. Given the complexities of the market, the complexities of corporate behaviour and ongoing financial innovation, regulators need sophisticated and flexible powers like the banning power, but they need to be in a position to exercise them appropriately and to follow them up to make them stick, particularly where the profile of the matter or individual does not cause the banned individuals to stand out from the crowd. Whilst useful as a device for public humiliation and punishment, they have necessary limitations.
The banning order is however a relatively soft option. Banned individuals can continue to be involved in business outside managing a company. ASIC needs to be sure that it doesn’t pursue the soft option when the case is better dealt with through criminal conviction.

Red tape reduction a long, bloody and fruitless quest or a noble adventure?

2006-05-04T17:30:00.000+10:00

Introduction
While it takes 201 less days to start a business in Australia, than it does in Haiti, there is a perception that our governments are too quick to go for blunt regulatory fixes, when sometimes there are better alternatives: education or in some cases nothing at all.
Like Arthur’s knights the Commonwealth Government has sent a taskforce off after the Holy Grail of “alleviating the compliance burden on business from Commonwealth Government regulation” [http://www.regulationtaskforce.gov.au/media/index.html]. The Taskforce has now finalised its report and provided it to the Prime Minister and Treasurer.
Regulation reform is also being considered on a number of other fronts including COAG’s review of National Competition Policy, the Board of Taxation’s review of aspects of taxation legislation, and the Financial Services Reform Refinements project.
To many people our laws at state, commonwealth and local government levels are too draconian, too prescriptive and too rules-bound. That said ministers and their departments are anxious to preserve the regulatory outcomes on which they have been elected. Most regulations are designed to achieve goals such as better safety or a cleaner environment but that leaves a lot of regulation that is just reporting and red tape.
Better regulation can do away with a lot of the load on business freeing capital for more productive investments. Regulation reform promises many benefits. Not only would it save companies money and increase their competitiveness, but more competitive and prosperous companies add more to government revenues.
The current regulatory environment
The Business Council of Australia (BCA) has identified characteristics of the current regulatory environment that underlie these costs:
 Conflicting, overlapping and inconsistent regulation.
 Constantly changing laws.
 Multiple and uncoordinated licensing and approval processes.
 Lack of clarity regarding the roles, powers and objectives of regulators.
 A “zero-tolerance” attitude displayed by regulators.
 The excessive focus on the personal liability of directors and officers.
There are a number of straightforward steps that could be taken by governments to reform the basic structures of regulation making and compliance.
There is scope for a proper assessment and consultation processes that allows business and others to identify overlapping regulation and unintended consequences before new regulation and legislation comes into effect.
A number of bodies and procedures have been in place in an attempt to manage the introduction and operation of regulation. Australia has built in regulatory reform by including “sunset” provisions in new regulations, with the regulation automatically expiring after a certain period unless renewed by Parliament. Additionally, the Office of Regulation Review vets each proposed regulation using a “minimum necessary regulation” principle.
In 1996, the Office of Regulation Review was charged with cutting the regulatory burden on small businesses in half, with annual reviews of progress achieved. One issue that the Regulation Taskforce will need to address is why the Office of Regulation Review has not been able to make any real headway to wards this goal.
Recommendations for Further Change
A number of organisations are calling for a far more significant and widespread overhaul of the current Australian business regulatory environment.
In response to the major causes of excessive compliance costs identified above, the BCA has made the following recommendations:
 To prevent the adoption of conflicting, inconsistent or overlapping regulations, a stricter regulatory assessment process should be introduced which would include standardised methodology for measuring the likely costs to business. Standardised definitions and commonly used clauses should also be developed.
 To minimise the burden of frequent changes in the law, there should be one date per year when all new legislation comes into force. Transition periods for new regulations should be extended.
 One-stop shops for project facilitation and approval should be created to avoid dealing with multiple and uncoordinated processes.
 The role and aims of regulators need to be clarified. Interaction between regulators should be increased.
 The zero-tolerance approach to regulation and compliance needs to be modified.
 To avoid a heavy focus on personal liability and the associated high costs of compliance, individual liability should only be introduced in exceptional circumstances.
Other suggestions include structural impediments to the slow the proliferation of regulation throughout government like a mandatory review of the utility and effect of regulation at a fixed time after coming into force, and a practice of releasing draft regulatory impact statements for public perusal and comment. A two-tiered impact assessment process has been advocated whereby all proposals would be assessed and those likely to have a significant effect upon business would then be subject to further in depth assessment. Whilst it seems simplistic, maybe government could agree to remove an existing rule for each new one that it introduces. Mayber ministers ought to pledge to measure the administrative cost of existing regulation and set reduction targets?
A final important suggested change is a move towards a single, consistent national regime in areas of regulation where there is shared responsibility across multiple jurisdictions.
Another good idea is from the National Institute of Accountants (NIA) who has called for the establishment of a one-stop shop to gather information from businesses that can be accessed by state and federal government agencies.
The idea is that such a move would eliminate the duplication of government requests with which businesses are expected to comply. What the NIA are suggesting is a “lodgement portal” where information could be housed, with state and federal agencies being given access, as well as being a place for lodgement of regulatory payments and information.
This idea if acted upon could avoid business having to provide the same information in different forms to different government authorities.
Indeed, many of the government’s regulatory requirements could be channelled through such a one-stop shop to reduce duplications while passing on cost savings to business.
What should the government be doing?
Good regulation does not mean zero regulation. The government needs to be involved in various aspects of control of business. The World Bank has recognised that government regulation should be able to impose essential controls on business without imposing an unnecessary burden.
The optimal level of regulation is not none, but may be less than what is currently found. We know that changes like Basle, the Financial Services Reform Act, anti money-laundering legislation and many others are a huge cost for everyone to bear when a very small minority are fraudsters and we know that more rules are not going to stop lying and cheating and stealing money.
In Australia, where private markets are functioning, competition is a suitable substitute for much of the need for regulation. By combining simple regulation with good governance and the protection of property rights, it should be possible to have government regulators serve as “public servants, not public masters”.
The Government can and should make a contribution to better regulation. For example agencies and arms of government should employ standard definitions across all regulation and legislation, look for self-regulatory models where appropriate, use uniform national legislation where possible, and develop a drafting style emphasising the spirit rather than the letter of the law.
As James Surowiecki wrote recently in The New Yorker [http://www.newyorker.com/talk/content/articles/051212ta_talk_surowiecki] poor regulations can and do have significant effects inflicting what economists call “social costs” on the economy as a whole. Look at the distortions caused in the builders’ insurance market by HIH’s unsustainable market practices. We accept that regulation has a role not just to punish fraud but to prevent it from happening in the first place and that in a lot of cases the law's costs are a lot more visible than its benefits. It’s all a question of balance.

References/links
 See “A vow to cut red tape? It's just a pink elephant” Katey Lahey The Age 13/12/05 http://www.theage.com.au/news/business/a-vow-to-cut-red-tape-its-just-a-pink-elephant/2005/12/12/1134236003905.html
 “The Regulatory Balancing Act” Senator The Hon. Helen Address to the Financial Services Accountants ssociation Annual Conference 17 May 2004 http://assistant.treasurer.gov.au/atr/content/speeches/2004/008.asp
 Sarboxed In? http://www.newyorker.com/talk/content/articles/051212ta_talk_surowiecki
 The World Bank Doing Business 2004 and 2005 reports on "Understanding Regulation" http://rru.worldbank.org/Documents/DoingBusiness/2004/DB2004-full-report.pdf
 Office of Regulation Review http://www.pc.gov.au/orr/
 Taskforce on Reducing the Regulatory Burden on Business http://www.regulationtaskforce.gov.au/
 The Boardroom Report Volume 3, Issue 24, December 16th, 2005. http://www.companydirectors.com.au/StaticContent/boardroomreport/051216/item01.html
 One-stop-shop will cut red-tape burden says NIA 20/12/2005 http://www.nia.com.au
 AICD submission http://www.companydirectors.com.au/Policy/Submissions/2005/
 BCA submission http://www.bca.com.au/content.asp?newsID=99412

Red Queen Race

2006-03-17T12:00:00.000+11:00

Accordingly, the metaphor Red Queen represents the situation in nature where creatures must adapt quickly to changing environmental threats just to survive from generation to generation. In Through the Looking Glass (Lewis Carroll Through the Looking-Glass and What Alice Found There), Alice complains that she has to run just to stay in the same place.

Well, in our country," said Alice, still panting a little, "you'd generally get to somewhere else -- if you ran very fast for a long time, as we've been doing.

A slow sort of country!" said the Queen. "Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!

References
Bell, G. (1982). The Masterpiece Of Nature: The Evolution and Genetics of Sexuality. University of California Press, Berkeley, 635 pp.

Lewis Carroll. 1960 (reprinted). The Annotated Alice: Alice's Adventures in Wonderland and Through the Looking-Glass, illustrated by J. Tenniel, with an Introduction and Notes by M. Gardner. The New American Library, New York, 345 pp. Through the Looking-Glass and What Alice Found There

Dawkins, R. & Krebs, J. R. (1979). Arms races between and within species. Proceedings of the Royal society of London, B 205, 489-511.

Pearson, Paul N. (2001) Red Queen hypothesis Encyclopedia of Life Sciences http://www.els.net

Matt Ridley (1995) The Red Queen: Sex and the Evolution of Human Nature, Penguin Books, ISBN 0140245480

Leigh Van Valen. (1973). "A new evolutionary law". Evolutionary Theory 1: 1—30.
Vermeij, G.J. (1987). Evolution and escalation: An ecological history of life. Princeton University Press, Princeton, NJ.

Retrieved from "http://en.wikipedia.org/wiki/Red_Queen"

The anthill mob

2006-02-27T10:16:00.003+11:00

The anthill mob
09 April 2005

From New Scientist Print Edition.

On a recent summer trip to Ushuaia in Patagonia, Argentina, we saw no ants. This troubled us so much that we ended up actively searching them out, with no success.
Is there a southern - and indeed a northern - limit to the range of ants or were we just looking in the wrong places?

Andrew and Bronwyn Lumsden, Murrays Run, New South Wales, Australia
From issue 2494 of New Scientist magazine, 09 April 2005, page 81\

In searching around Ushuaia, the questioners found one of the few places on land where ants do not occur naturally, although there is the possibility that adventive species - that is, non-native and non-established ants - survive in houses. It's just too cold and wet there. Other places where you can look in vain are Antarctica, the sub-Antarctic islands (although an adventive species was found once in an abandoned whaler's hut on Kerguelen), the Falkland Islands, the high Arctic, Iceland and the upper slopes of high mountains.

Edward O. Wilson, Department of Entomology, Harvard University, Cambridge, Massachusetts, US

From issue 2678 of New Scientist magazine, 15 October 2008, page 81

A short walk up a long mountain - a 'hike' to intermediate camp

2006-01-28T06:25:00.000+11:00

At 5360 metres it was never goin to be easy. Every breath was hard, every step exhausting, but it was worth a go and when the Chinese team members said did I want to join them for a "walk" to Camp 1 I thought, why not!

Camp 1, Intermediate Camp isn't used that much these days. It had beeen used extensively in the 20's when expeditions like the one where Mallory and Irving were lost. But for a novice hanging at at the base of the most magestic mountian there is it was a pretty cool prospect.

I fel into line with the yak herders who whistle and throw stones to keep their animals moving along, walking wth yaks the air is always filled with the sounds of bells and hooves. Apparently this is as far as the yaks go and I can see why, indeed apparently they call Camp 1 the yak camp.
It started easily enough, crossing the flood plain of the Rongbuk River, then weaving along a good path between the glacier and the valley side. Then you leave the main Rongbuk valleywhich then opens up to reveal what I think was the East Rongbuk Glacier, that was really something.

Glipses of Qomolangma , this is a serious hill! The sight of the mountain is awe-inspiring and you can spend countless hours watching the changing faces of the mountain. But we can't stop to look, me and the yaks have to keep walking!

Maybe I should have stayed at the Monestry this is too hard, the terrain is not that difficult but ... I'm totally knackered, I guess I'll put that down to the altitude.

Bhutan

2006-01-20T09:11:00.000+11:00

Dragon's Nest Monestary and rice fields in Bhutan

The famous Dragon's Nest monastery burnt down but was rebuilt.

Dragon's Nest

2006-01-19T18:24:00.000+11:00

“Never get outta the boat”

2006-01-11T11:28:00.000+11:00

“Never get outta the boat” [1]
Andrew Lumsden, Partner, Corporate Advisory, Corrs Chambers Westgarth
Introduction
Recently, the investment community has raised serious questions about Australian company’s ability to successfully expand offshore. The critic cite everything from an inability to define competitive advantage or articulate smart strategies to the lack management skills.
In March this year Peter Morgan of 452 Capital told financial planners that he would never invest in an Australian company that expanded overseas.[2] These comments were made some weeks after Telstra announced a write-down of its Asian business operations but before AMP wrote off $2.6 billion on its business in Britain.
“Why if there’s such a good deal to be done overseas would a seller come to Australia first?” Peter Morgan was reported as saying. “It’s because their second-rate deals”
Expanding offshore allows Australian companies to access bigger markets, as well as diversifying risk across markets and currencies. Offshore investment facilitates exports by building networks in overseas markets. In the 12 months to 30 June 2001,Australian companies invested $417 billion more than 42% of this was direct investment.[3] Understanding why their endeavours should be supported and how to do it successfully is an issue of major significance to the nation.
A recent survey of large enterprises by the Productivity Commission found that 50% of firms reported that offshore investment had increased their overall profitability and 35% reported higher exports as a result of foreign direct investments.[4]
The issue often comes down to a willingness and capability to learn from experience (even if some experiences are frightening) and clearly articulating skills and expertise. We cannot support calls to never to leave the comfort of domestic shores for fear of confronting the jungle of overseas business. The consequences of failing to embrace the global jungle are substantial and one consequence of an unwillingness to ‘explore’ is Australia ending up as a mere branch office of global companies.
Is there one story?
There is no doubt that the field is filled with mixed stories, Australian companies have set off into the jungle as “national champions” but have returned wounded, their tails between their legs with the sweet fruit left somewhere else.
Some of our most respected companies have been involved, including National Australia Bank with Homeside, BHP with Magna Copper, Lend Lease and its US investment business, Telstra’s Asian operations and many others. Southcorp has run into trouble because of its distribution strategies overseas (rather than its foreign acquisitions).[5] Smaller companies in boutique markets such as Wattyl, Country Road and Aristocrat have also had frightening trips through the jungle of overseas.[6]. One survey estimated that in the past five years, 20 Australian companies have lost almost $40 billion in write-downs and losses in overseas investments. The problem is not just individual company failures; overall foreign investment performance is poor. Three of the four biggest markets for Australian direct investment fail to produce returns above the bond rate.[7]
Then again, a few such as Foster's Group, Westfield, Leighton Holdings, News Limited, Amcor (second attempt), CSR, James Hardie have enjoyed long-term success honed from an Australian business model and it remains to be seen if more recent adventures off the boat like Macquarie Bank's investments in Asia and more broadly, ANZ's Asian business development, Computershare offshore business can be made successful.
What’s the problem?
Why are so few Australian corporations able to globalise successfully?
Australian markets are small. If the most successful Australian companies cannot grow larger domestically, they are left with little choice but to expand overseas, accept a foreign takeover offer, or try and do both at once by way of a dual-listing merger with a foreign firm (Rio Tinto, BHP Billiton, and Brambles). There is a widespread suspicion that the headquarters of dual-listed companies will gradually drift overseas,relegating the former Australian head office to branch-office status.[8]
Management theory holds a successful global strategy has three elements - development and domestic refinement of a sound core strategy; internationalising the core strategy through expansion of activities and adaptation of the strategy; globalising the strategy by integrating it across countries.[9]
Why persist?
As one recent commentator put it “The choice is simple: either stay dominant in a domestic oligopoly and manage declining profitability by continually finding ways to slash costs, or find new overseas revenue.”[10] History would suggest that the other alternatives are not likely to serve Australia well. Selling to an overseas acquirer or returning cash to shareholders adds little to the wealth of the nation.
Another common reason for Australian companies' difficulties in developing a global presence is their lack of size. Many argue that we should modify the domestic market concentration restrictions to allow companies to develop that are able to compete in the global marketplace. An alternative view is that given the size of Australia’s marketplace dominating a sector completely diminishes the company’s ability to utilise alliance s effectively. Powerful companies that dominate all parts of the Australian value chain may find it difficult to adjust to the role of alliance partner (possibly in a minority role) and to extract value from the alliance.
Despite the high risks and difficulties associated with leaving the safety of the boat, Australian companies cannot afford to listen to the short-term demands of the investment community.
Structural adjustment
The existing franking credit system means that foreign-sourced income however is ineligible for a franking credit. Thus investors, who are being taxed at the highest marginal rate of 49%, are effectively paying 64.3% tax on dividends paid to them as a result of foreign-sourced income. Investors are penalised for investing in Australian companies who are becoming more global and receiving larger and larger shares of their operating revenues from foreign sources.
This is counter-intuitive for investors in small countries as their companies attempt to become successful in foreign markets and hence become a more secure and diversified investment providing improved returns.[11]
Allowing streaming of dividends to foreign shareholders from foreign revenue, without reducing franking credits for locals would be a significant step helping to address this imbalance. So would modernising the “controlled foreign corporation” rules to reduce compliance in countries with comparative tax levels. Add to that a change to the definition of corporate tax residence so that Australian companies can have greater flexibility in the operation of overseas subsidiaries.[12]
Conclusion
The stories of the companies that have in fact been successful have some common threads. These include a sound overseas strategy that leverages off domestic experience and the persistence to learn from the inevitable errors[13] that follow any adventure outside the safety of ‘the boat’.
Hard lessons will be been learnt from overseas expansion. Managers must learn to under-promise and over-deliver It will almost invariably cost much more then budgeted and much longer than anticipated. The investment community must appreciate the need for patience and to manage their expectations. Our companies and their local investors must learn from their mistakes rather than retreating to the safety of the boat.

[1] With apologies to John Milius and Francis Ford Coppola. From Apocalypse Now:
CHIEF: You forgot the mangoes, didn't you?
CHEF: Mangoes? There as a fucking tiger in the woods -- I could've been eaten alive. I'm never going into that jungle again. I gotta remember never get out of the boat; never get outta the boat.
They move off; swallowed by the darkness. The jungle noises remain.
WILLARD (V.O.): He was right, the Chef – Never get out of the boat. Absolutely god damn right. Unless you were going all the way. Kurtz got off the boat. He split from the whole fuckin' program.
[2] Jan Eakin “Home truths and global warnings” The Age (Melbourne) 20/05/ 2003.
[3] Investing in Australia at http://www.dfat.gov.au/geo/australia/tradingnation/investing_in_australia.html
[4] Offshore Investment by Australian Firms: Survey Evidence, Productivity Commission, Commission Research Paper, , Feb-02
[5] Chris Wright “Overseas And Under Water” Australian Financial Review 24/05/2003.
[6] Bill Beerworth “Going global needs right model” The Australian Financial Review 06/05/2003.
[7] Adele Ferguson and David James “Secrets and traps” Business Review Weekly 06/05/2003 pg 40.
[8] Bill Beerworth “Going global needs right model” The Australian Financial Review 06/05/2003.
[9] Bill Beerworth “Going global needs right model” The Australian Financial Review 06/05/2003.
[10] Adele Ferguson and David James “Secrets and traps” Business Review Weekly 06/05/2003 pg 40
[11] Skontnicki Tom “The branch-office economy fights back” Business Review Weekly 06/5/2001 pg 35
[12] The Government has announced an intention to consider these matters “Review of International Taxation Arrangements – Consultation Paper” 26/08/2002
[13] Adele Ferguson and David James “Secrets and traps” Business Review Weekly 06/05/2003 pg 40 The authors survey a number of companies and conclude that the reasons include: failure to stick closely to core areas of expertise; failure to take a long-term strategic view; flooding the foreign acquisition with second-rate expatriates who do not understand the culture, market or legal system; paying too much for the business; failure to manage synergies; and an inability to buy the number-one or number-two business. In addition, Australian companies' lack of size makes it difficult to use acquisitions to create cross-border advantages between different consumer and financial.

Audit Committee Membership and its Consequences

2006-01-11T10:58:00.000+11:00

ANDREW LUMSDEN
Partner Corporate Advisory, Corrs Chambers Westgarth
(a) There has been an extraordinary run of recent actual or perceived financial failures: Halliburton, Enron, Dynergy, Adelphia, Tyco, WorldCom, , , Global Crossing and Qwest have all been mentioned. In Australia, we have had Harris Scarfe, One.Tel and HIH. Phrases like “earnings management” are now in common parlance. Before the real lessons from any of these “failures” have been learnt, public pressure for accountability and reform will intensify. Nowhere will the pressure be more acutely felt than around those board tables where audit committees meet to discuss their financial statements. Earnings have always and will always be “manageable”. The application of accounting principles to a business always involves fine judgment. This article suggests a number of practical measures that audit committee members can take to ensure they are satisfying their obligations under Australian law as directors and delegates and that their discretions are being exercised in reasonable way.

(i) Introduction
Too often our media fail to recognise that financial fraud is a sophisticated business. That is why boards of directors, regulators and auditors find it so hard to stop. In a world where equity markets are unforgiving and management compensation is tied to the achievement of higher earnings, pressures cascade through an organisation and translate into pressure on financial management, audit committees and auditors.
The audit committee has become the subject of considerable focus as a way of cracking down on fraudulent financial reporting and more effective monitoring of the financial reporting process. The focus of recent times has been on the audit committee while there has been surprisingly little attention given to the potential liability of committee members.
A well functioning audit committee is an important element of good large company corporate governance, but it is not a universal panacea. The best and most diligent will sometimes be deceived. That is not to say regulators should capitulate, rather, we need to recognise the limitations of regulation.
The importance of accurate financial information cannot be underestimated; it is the lifeblood of markets, and our scheme of corporate regulation needs to actively preserve the integrity of financial information. In the near future it is likely that one of the costs of participating in public financial markets will be the necessity to establish, resource and supervise an audit committee.
Given the importance of the audit committee in enhancing financial statement reliability and credibility, there will be increasing pressure on companies (via either the ASX, in accordance with the recommendations of the Ramsay Report, or through market pressure) to establish independent audit committees. Already more than 186 of ASX top-200 companies have audit committees; of these only 26 included executive directors.
The push to a greater monitoring role for audit committees means they will be charged with greater liability for the failure of financial reporting systems over and above their existing liability as directors of the company. There have been recent statements by the United Kingdom Financial Services Authority (FSA) that it believes it is appropriate to look to the audit committee if there is an audit failure. This trend will most likely be replicated if and when the audit committees of HIH, Enron, WorldCom etc come before the courts. The audit committee will assume primary responsibility for the oversight of the company’s financial statements, possibly to the exclusion of all other directors.
There are concerns that the increasing focus on the audit committee as the governance instrument responsible for the regulation of financial management has brought with it increased liability for audit committee members. The following discussion focuses on the theoretical and practical potential liability of audit committee members and how, if properly followed, procedures could be established to manage and possibly reduce an audit committee’s existing exposure to liability.
(A) Audit “failure”
An important rationale for the audit committee is to reduce the risk of audit failure. Audit failure generally refers to an instance where a company’s financial statements are materially misstated and either “failed to discover the misstatement or acquiesced in the inclusion of the misstatement in the company’s financial statements”. An audit failure may precede a corporate collapse that might otherwise have been avoided, possibly where an industry regulator chooses to rely on financial statements that have been audited by a reputable accounting firm.
(ii) What is an audit committee
The board is responsible for managing the company. It delegates its management to executives who are responsible for the day-to-day management of the company and to various specific board committees to oversee particular areas in a review or advisory capacity.
The ability of a board to effectively monitor the company’s financial performance is increasingly being focused through the audit committee. The audit committee is seen as the monitor of the company’s financial integrity and internal controls; the board’s “structured and professional vertical probe”.
An appropriately structured and qualified audit committee plays a key role in assisting a board fulfil its overseeing responsibilities to oversee financial reporting, internal control structure, risk management systems and the internal and external audit functions. The committee also provides an effective mechanism for the auditor to communicate in an informal and private way with the directors (assuming the committee is composed, entirely of independent non-executive directors) about these issues as well as potentially troublesome issues at a relatively early stage and to broach sensitive issues in an uninhibited fashion.
Virtually all sets of corporate governance guidelines recommend that boards of large and/or publicly listed companies should have (at least) an audit committee. However, the Corporations Act, common law and the ASX Listing Rules do not provide much guidance on how the audit committee should be structured or how it should function.
A listed company is required to disclose in its annual report whether it has an audit committee. If it does not have one, it must disclose why. There is no requirement to say anything about the composition or functions of the committee. Listed companies are also required to ensure that their financial statements contain a statement of corporate governance practices operating during the reporting period, including rules for the nomination of external auditors and reviewing the existing external audit arrangements.
(iii) Overseas practice
Throughout the mid to late 1990s the SEC was making noises about the integrity of the reporting of American public companies. There was a clear feeling in the United States that market expectations would lead to greater levels of “earnings management”. The quarterly reporting model put substantial pressure on United States management to achieve Wall Street’s predictions – consequently some US management pushed the boundaries of United States GAAP in preparing their financial reports.
The NYSE and NASD Blue Ribbon Committee on improving effectiveness of corporate audit committees was established with the SEC’s encouragement to examine and make recommendations to monitor earnings management oversight by audit committees.
In summary the Blue Ribbon Committee recommended:
• mandated audit committees for all large listed companies comprising a minimum of three directors, each of whom is independent (where independence is rigorously defined), financially literate or who becomes financially literate within a reasonable period of time after his or her appointment and where at least one member has accounting or similar expertise;
• the adoption of a formal charter. The charter must specify that the audit committee is responsible for several matters. First, for ensuring that the auditor submits periodically to the audit committee a formal written statement delineating all relationships between the auditor and the company. Second, for actively engaging in a dialogue with the auditor regarding any disclosed relationships that may impact the auditor’s objectivity and independence. Third, for recommending that the board of directors takes appropriate action in response to the auditor’s statement to satisfy itself of the auditor’s independence; and
• the company must file a “written affirmation” with the exchange each year, and after any change in the audit committee’s composition, disclosing the audit committee’s members and confirming that the company is complying with the requirements summarised above.
In the United States the Sarbanes-Oxley Act 2002 deals with corporate responsibility and enhanced financial disclosure. It provides that the audit committee is directly responsible for the appointment, compensation, and oversight of the work of the public company auditors.
The Sarbanes-Oxley Act provides that the audit committee members must be independent from company management. It requires that the audit committee develop procedures for addressing complaints concerning auditing issues and also that they put in place procedures for employee whistleblowers to submit their concerns regarding accounting. The legislation specifically provides that an employee should be protected in going to the audit committee.
In the United Kingdom the Combined Code recommends that companies have an audit committee, and that the committee consist exclusively of non-executive directors (with at least a majority being independent non-executives). Listed United Kingdom companies must disclose annually whether they have complied with the Combined Code’s recommendations and, if not, why not.
The experiences of these two dominant capital market jurisdictions (although different in emphasis) will most likely travel to Australia either by regulation or by the increasing uniform international institutional corporate governance expectations.
(iv) General obligations
The board’s responsibilities go beyond strategic matters. The Corporations Act imposes specific responsibilities on directors; for example, the directors have specific responsibility for the company’s financial statements.
Directors have statutory and fiduciary duties to shareholders to act in good faith in the best interests of the company and for a proper purpose. Individual directors and/or the individual members of the audit committee will be judged by this standard in circumstances of audit failure (for example, failure to prevent earnings management).
Our courts have not separately reviewed the role of an audit committee as distinct from the director’s role as a board member. Further there is some doubt about whether the kind of distinctions drawn by Rogers CJ in AWA Ltd v Daniels (1992) 9 ACSR 383 regarding executive and non-executive directors can be sustained. To be liable under s 181 the committee member would need to be shown not to have acted with “the degree of care and diligence that a reasonable person would exercise if they occupied” the position of an audit committee member and to not be entitled to the protection of the business judgment rule.
While the case law in the United States is sparse, United States courts have found that audit committee members have an obligation “to question the information being presented to them”. The general theme of the United States cases is that audit committee members are “inside directors” and as such have a heightened exposure to liability, that is they have a higher monitoring obligation than non-audit committee members and other non-executive directors.
In Australia after Daniels v AWA (1995) 16 ACSR 607 (AWA appeal) decision the position is not clear regarding the level of duty imposed on executive and non-executive directors and axiomatically between committee members and other directors. The better view is probably that the standard of reasonableness expected of directors varies depending on the level of understanding of the relevant director and their role, for example as audit committee member (see below).
An Australian court is likely to assess whether the audit committee members have satisfied their statutory and common law obligations to act with a reasonable degree of care and diligence by reference to industry practice. The best current guide to industry best practice is Audit Committees: Best Practice Guide and the Ramsay Report. In order to satisfy their obligations, audit committee members need to see these “standards” and their own charter as benchmarks against which they will be judged.
(A) Business judgment rule
Under the statutory business judgment rule the court will only review the committee’s decision regarding say, earnings management, for rationality provided the prerequisites in s 181(2) of the Corporations Act are satisfied.
In the present context probably the most important prerequisite for the application of the business judgment rule is that the committee members have informed “themselves about the subject matter of the judgment to the extent they reasonably believe appropriate”, that is, the audit committee came to an informed decision.
Embracing the Ramsay Report recommendations regarding process would substantially aid an audit committee in demonstrating that its decision was an informed one and thus ought to be entitled to the favourable presumption of the business judgment rule.
If the audit committee examined the financial statements, discussed them with management and the outside auditor and took steps to investigate the independence of the outside auditor (see a more detailed discussion of the probable best practice steps below) before deciding whether to recommend the financial statements, it would be very difficult for a court to conclude that they had failed to appropriately inform themselves about the quality of the financial statements before recommending them to the board.
(1) Avoiding conflicts of interest
If audit committee members wish to avail themselves of the business judgment rule they will need to be continuously vigilant to identify circumstances of conflicting interests, that is, circumstances where they have a material personal interest in the matter before the committee. If, for instance, committee members hold significant numbers of share options that vest during the reporting period, they may well have a disqualifying personal interest. In ASIC v Adler [2002] NSWSC 171, Santow J held that Mr Adler and Mr Williams each as major shareholders in HIH had “a material personal interest precluding the application of the business judgment rule”.
If for some reason the business judgment rule is not available, following the processes referred to in the Ramsay Report recommendations could protect audit committee members from claims that they breached their duty of care to act with a reasonable degree of care and diligence. A diligent focus on the Ramsay Report recommendations will demonstrate that even though the committee may have recommended to the board financial statements, which later prove to be wrong, they will not have been in breach of their directorial obligations.
(B) Delegation and its consequences
The Corporations Act recognises that the directors may delegate their powers to a variety of people including a committee of directors. Once delegated each director is responsible for the exercise of the power by the delegate as if the directors themselves had exercised the power unless the directors can establish that the committee was reliable and competent in relation to the power delegated. Clearly a properly constituted and qualified audit committee can effectively shift primary liability for the monitoring and preparation of the company’s financial information to the audit committee.
The Corporations Act allows the directors to delegate their powers regarding financial matters to the audit committee. Section 189 provides specific authority for the rest of the board to reasonably rely on information or advice provided to the board by the audit committee; however, the provision requires that the board make an independent assessment of the “advice, having regard to [their] knowledge of the corporation and the complexity of the structures and operations of the corporation”. The provision does not require the board to separately have the audit committee determinations reviewed by, for example, an independent expert accountant but it does require them to have listened to and assessed what is being proposed by the audit committee. They must bring their own mind to bear on the issue using such skill and judgment as they possess.
The board should also ensure they adopt a written charter to govern the audit committee and establish the reasonableness of their reliance on the information coming to the board from the audit committee. If the directors have taken these steps then they will usually have established that they have satisfied their statutory and common law duties irrespective of the audit failure.
Adopting the charter alone is not sufficient; there should be an annual assessment by the audit committee of the adequacy of the charter. The audit committees (and boards of directors as a whole) should carefully review and, if necessary, update their audit committee’s charter to ensure that it not only meets the applicable requirements but also properly addresses the role the committee will in fact play in the financial reporting process. Audit committees should consider what, if anything, different from the past they will do. In addition, the audit committee should assure itself that in the course of its activities it in fact addresses the matters the charter contemplates that it will address.
(v) Practical steps to satisfy the obligations of audit committee membership
The role of the audit committee in most modern public companies is to engage in the pro-active oversight of the company’s financial reporting and disclosure process and the outputs of that process. Obviously, the committee is not responsible for the day-to-day tasks involved in making sure of the accuracy of the accounts. That is the role of management. Nor are they liable to micromanage the finances of the company. However, relying on the external auditor, financial management and internal auditors, the committee must exercise a high level of due diligence into the accuracy of the final statements.
During my almost eight years at the Commission, I have come to believe that one of the most reliable guardians of the public interest is a competent, committed, independent and tough-minded audit committee. The audit committee stands to protect and preserve the integrity of America’s financial reporting process. I encourage your committee to take every step possible to ensure that the integrity of the financial statements, and by extension, the interest of shareholders, remains second to none … [The] audit committees should encourage a “tone at the top” that conveys basic values of ethical integrity as well as legal compliance and strong financial reporting and control.
(A) Composition
Having regard to overseas practice and Ramsay Report recommendations, it is more than likely that in the near future audit committee members will need to have a reasonable level of financial literacy. However, the law and/or the ASX Listing Rules are not likely to go so far as to require every member of the committee to be an accountant.
All the members of the audit committee must be “independent”. An audit committee member will only be independent if he or she has no relationship with the company that may interfere with the exercise of independent judgment; the Ramsay Report recommendations set out a possible set of criteria to determine independence. Similarly, the chair of the board of directors should not be the chair of the audit committee. The Sarbanes-Oxley Act on the other hand defines independence by reference to the absence of any consulting, advisory or other compensatory fee from the company and the absence of any affiliation with the company or any subsidiary, in this context affiliation probably refers to any commercially beneficial arrangements.
In the United States a distinction exists in audit committee independence requirements between small capitalisation and large capitalisation companies. This distinction recognises that requirements for independent directors can be costly and that this cost may be relatively higher for small capitalisation companies than for large capitalisation companies. In the case of smaller companies (say less than $100 million market capitalisation) the audit committee requirements may vary so that they contain at least one director meeting the independence criteria, instead of all directors of the audit committee being required to meet the independence criteria.
(B) Duty to monitor
The directors of a company have a duty to monitor the company and its employees. Specifically, the directors collectively have a duty to ensure that there is an adequate corporate information and reporting system. Management’s accounts are subject to review by the auditor; the role of the committee is to monitor.
Adopting the sorts of processes identified below will help the audit committee demonstrate that it took steps to assure itself that it obtained the information needed to properly monitor the executives’ creation of financial statements and the auditors’ review. The committee should establish a system of overseeing the external reporting of the company.
Audit committees are uniquely positioned to oversee the construction and operation of a company’s financial affairs. If the actions and influence of audit committees are to be real they must extend beyond prescribed rules, obligations and responsibilities. The boundaries of an audit committee’s effort must be guided by an unwavering commitment to investors and a dedication to the integrity of high quality financial reporting.
The functions discussed below are designed to operate as indicia of best practice that, if followed, should provide evidence of the committee’s meeting its common law and statutory obligations. The following are not intended to suggest that the audit committee’s focus should shift from oversight to active management.
(C) Financial reporting
The audit committee has a key role in monitoring the component parts of the audit. In this pivotal role, aptly described by the Blue Ribbon Committee as “first among equals”, the committee oversees management who have and must accept the primary responsibility for the financial statements. It is important that this oversight role be timely, robust, diligent and probing.
The committee should be aware of the many specific periodic and continuous filing obligations and work with management to settle a work program to ensure adequate time is available to meet each of the financial filing obligations imposed on the company, some of these include:
•
•

• preparation and distribution of full and half year reports (full or concise) reconciled with any preliminary final report;
• information likely to have a material effect on the value of securities, as and when the company becomes aware of it;
• preliminary final report in the form set out in Appendix 4B of the ASX Listing Rules.
Warren Buffett, a major investor, has suggested that audit committees ask auditors:
1. If the auditor were solely responsible for preparation of the company’s financial statements, would the reports have been prepared in any way differently from the manner selected by management? The audit committee should inquire as to both material and non-material differences. If the auditor would have done anything differently from what management would have done, an explanation should be made of management’s argument and the auditor’s response.
2. If the auditor were an investor, would he have received the information essential to a proper understanding of the company’s financial performance during the reporting period?
3. Is the company following the same internal audit procedure that would be followed if the auditor himself were CEO? If not, what are the differences and why?
In a similar vein Mr Harvey Pitt, the chairman of the Securities and Exchange Commission, has suggested that audit committees ask their auditors to identify the five assumptions that make the biggest difference to the companies’ financial statements and to show how the numbers would look if different assumptions were made.
In the United States the Sarbanes-Oxley Act also requires that the auditor report to the audit committee:
(1) all critical accounting policies and practices to be used;
(2) all alternative treatments of financial information within generally accepted accounting principles that have been discussed with management officials of the issuer, ramifications of the use of such alternative disclosures and treatments, and the treatment preferred by the registered public accounting firm.
Additionally, s 401 of the Sarbanes-Oxley Act requires all financial statements that are prepared or reconciled to United States GAAP to reflect all “material correcting adjustments” that have been identified by an auditor in accordance with GAAP and SEC rules and regulations.
While probably now of little more than historical interest it is worth noting that the Second Corporate Law Simplification Bill 1996 included a general management discussion and analysis (MD&A) requirement that was omitted from the Bill in favour of a requirement to discuss in general terms information relating to a company’s operations and activities. This change was strongly opposed by the Securities Institute of Australia, the Accounting Bodies together and many other key organisations, including IFSA:
The MD&A would help users of financial reports to understand a company’s performance, financial position and future prospects. The Accounting Bodies believe that the absence of a regulatory framework for MD&A disclosure in Australian company reports is a significant shortcoming in the quality of financial reporting to users, especially as this form of reporting is required or encouraged in other major capital markets, such as the United States, United Kingdom and Canada. We do not believe that the Bill’s approach, that is, allowing the provision of a MD&A to be voluntary is appropriate. Although directors can incorporate interpretative information on the financial statements, our observations indicate that among a cross-section of companies of different size this type of information is not generally reported.
A different view on the need for a MD&A requirement was presented by the ASX who believed that a form of management discussion and analysis reporting was already required under the present Corporations Law requirements for directors’ reports. This misses the point of making the management (and the CEO and CFO in particular) separately responsible for discussion and analysis in the annual report; this is still an option available to Australian companies.
(D) Financial press releases
The audit committees ought to review and consider all the company’s publicly released material concerning financial information. There has been considerable recent criticism of press releases that convey an incomplete or inaccurate picture to investors; these have sometimes been referred to as an “EBS” or “Everything but Bad Stuff” release. Typically, these releases set forth the “pro forma” numbers before the actual operating results.
Audit committees need to view critically the company’s releases of financial information to ensure it is unbiased and balanced.
(E) Internal control structures and risk management systems
Many companies in Australia follow a best practice of including a management report on internal controls in their annual report to shareholders. Internal accounting controls are critical to the quality and timeliness of financial reporting by any company.
An effective audit committee ought to give due consideration to having the company include a report on the effectiveness of their internal accounting controls in the annual report. This will close the circle of reporting to the company’s shareholders by each of management, the independent auditor and the audit committee.
Each year, the audit committee should insist on and obtain from management a written report to the committee addressing whether the company’s internal controls are operating effectively.
Following the new United States rules the committee ought to consider developing procedures for addressing complaints concerning auditing issues and also that they put in place procedures for employee whistleblowers to anonymously submit their concerns regarding accounting or auditing issues.
(F) Internal audit functions
The audit committee should ensure that the internal auditor should have an unobstructed and clear communication channel to the audit committee. This is especially important today as the internal auditor can evaluate and report to the audit committee on the adequacy and effectiveness of a company’s internal controls. The internal audit functions and adequate systems and control procedures are key in the preparation of reliable financial statements. History shows that financial frauds often involve the overriding of internal controls by a company’s chief executive officer and/or chief financial officer.
(G) Related party transactions
If there is no separate committee to review these types of transactions (and in general where there are large shareholders with which the company does business there should be) the audit committee should review the frequency and significance of all transactions with related parties and assess their propriety.
The audit committee should give particular regard to whether they ought to have the advantage of advice from an independent lawyer (not otherwise employed by the company) in these types of matters. Few independent directors know how to handle the type of transactions that can be involved with related parties (whether management or shareholders). The committee will often benefit from advice from independent and experienced solicitors who will appreciate what is involved and can advise the committee. Ideally this advice should be completely independent of any affiliation with management, and separate solicitors should be retained to independently advise the committee. The solicitors should be providing the committee with written advice.
In this context “independent” refers to the restrictions on relationships between the solicitors providing the advice and management and/or third parties that might affect the solicitors’ capacity to provide zealous representation and advice to the audit committee and should be determined in a way that is consistent with the committee’s approach to audit independence.
(H) Management letter comments
Auditors often identify improvements that can or should be made to a company’s internal controls, policies and financial disclosures. The auditor typically communicates these observations to management and the audit committee in what is referred to as a “management letter”. This letter is a valuable and integral part of each audit.
The audit committee should ensure they are provided with a copy of all management letter comments. It is important that this be obtained on a timely basis at the completion of each audit. In some cases, auditors may also provide management letter comments as they complete their interim audit procedures or their reviews of the quarterly financial statements.
In addition to obtaining a copy of the management comment letter, audit committees should have an in depth discussion with the internal and external auditors regarding what changes or improvements should be made in internal controls, policies or financial reporting processes. Then the audit committee should discuss with management how those changes or improvements would be implemented.
(I) Audit independence
Audit committee members should understand the importance of the auditor remaining independent. Committee members should be familiar with the rules in s 324 of the Corporations Act concerning who can and cannot be an auditor, Australian rules on auditor independence contained in The AuASB’s Auditing Standard AUS 1, and Statement of Auditing Practice AUP 32 “Audit Independence”; and the two main professional bodies’ Code of Professional Conduct.
The committee should be vigilant to ensure that the auditors be, and be seen to be, free of any interest which might be regarded – whatever its actual effect – as being incompatible with integrity and objectivity. They must not allow prejudice, bias or conflict of interest to override their objectivity.
At a minimum to monitor auditor independence issues the audit committee should:
• be advised of plans to hire personnel of the audit firm into high level positions;
• be pro-active in ensuring factors, such as time pressures on auditors, are addressed so as not to negatively impact the credibility of audits; and
• pre-approve non-audit services above an established threshold and consider certain guidelines with respect to their discussions of the auditor’s independence.
The SEC’s new rules set out five situations that automatically impair an auditor’s independence:
1. Some types of non-audit services: these rules restrict the provision of services that:
• creates a mutual or conflicting interest between the accountant and the audit client; or
• places the accountant in the position of auditing his or her own work; or
• results in the accountant acting as management or an employee of the audit client; or
• places the accountant in a position of being an advocate for the audit client.
2. Financial relationships: For example, investments in the audited company by one of the audit firm’s partners or employees working on the audit.
3. Employment relationships: For example, a close family member of an audit partner is in an accounting role or financial reporting oversight role at the audited company.
4. Business relationships: For example, a business relationship between the audit firm and one of the audited company’s directors, officers or substantial shareholders.
5. Contingent fees: An audit firm is deemed not to be independent if the firm provides any service or product to an audit client for a contingent fee or commission.
For situations falling outside the five above, there is a general rule:
The Commission will not recognize an accountant as independent, with respect to an audit client, if the accountant is not, or a reasonable investor with knowledge of all relevant facts and circumstances would conclude that the accountant is not, capable of exercising objective and impartial judgment on all issues encompassed within the accountant’s engagement.
(J) Auditors’ accountability
The audit committee should review on a regular basis the relationships between management and the internal and external auditors. It is critical that the external audit engagement partner clearly understands that he or she is responsible to and serving the investors and audit committee, not management.
The audit committee should hire the auditors, evaluate their performance and, when necessary, dismiss them. The auditor ought to issue the audit engagement letter directly to the audit committee and the audit partner and audit committee must have a clear understanding of the terms of the engagement, scope of the audit and responsibilities of the auditor for reporting to the audit committee.
Audit committees should inquire about and ensure that the audit fee does not represent a “loss leader” being used to leverage the audit into other consulting engagements. They should also inquire about the compensation scheme for the audit partner and determine if it is affected in any way by the cross-selling of consulting services.
(K) Regularly scheduled meetings
Depending on the size of the company and the complexity of its business, the audit committee should meet no less than four to six times a year. Additional or extended meetings may very well be needed when events such as material acquisitions occur or for training provided by management to new committee members on the company’s accounting practices and business operations. This basic understanding is fundamental to the ability of audit committee members to be able to adequately fulfil their responsibilities.
Most financial frauds occur in companies where audit committees meet infrequently. The type of in-depth, robust dialogue that is called for requires regular meetings to gain sound advice from the auditors, both internal and external. There can be no in-depth probing into the quality of financial reporting done by management if there is not adequate time allocated to do so.
(L) Reporting
Clearly the committee must institute a system to accurately minute the work done to assess the financial statements of the company. An effective documentation trail will be essential to establishing compliance by the audit committee with its obligations. At a minimum each year management should provide a written report to the committee addressing the effectiveness of the internal management controls. History shows that most financial fraud cases have their genesis in the breakdown of internal controls at management level.
Another step is to accurately reflect the outcomes of candid discussions undertaken by the committee with management, the internal auditor, and outside auditors regarding issues implicating judgment and impacting quality.
As discussed above there may well be justification in including in the annual report a report on the effectiveness of the company’s internal accounting controls. This sort of disclosure from management emphasises to stakeholders that the triumvirate of auditor, audit committee and financial management is operating effectively.
(M) Self-review
Finally, an audit committee that follows best practices will no doubt elect to undergo an annual evaluation. Just as the board of directors evaluates the management team and the auditor, the audit committee should perform an annual self-assessment of its performance and obtain input from the entire board of directors. There should also be 360° review of the committee’s effectiveness by management and the internal and external auditor.
(vi) Implications for insurances
Even though the business judgment rule provides some statutory protection for directors, the reality is that there will be no shortage of proceedings against directors (and audit committee members in particular) in the years to come. Qualified individuals could reasonably be more expected to be reluctant to agree to sit on audit committees. If they do sit on them they will want the highest possible level of protection from claims against them using both indemnities in the constitution and comprehensive directors and officers liability insurance.
Practically, indemnities in the constitution are subject to strict limitations as to the matters for which a company can indemnify a director; these are essentially limited to legal costs in defending proceedings and claims by third parties. The most practical solution for protecting against liability is through directors and officers (D&O) insurance.
There are restrictions on the breadth of the cover that may be provided but these have no particular application to audit committee members and would not adversely impact the kinds of D&O insurance usually carried by public companies to cover directors in respect of liabilities incurred by them in the course of carrying out their duties as directors and, in particular, as audit committee members.
Audit committee members ought to carefully review the D&O policy exclusions and consider how these exemptions might limit the cover provided, that is, the insured versus insured, professional indemnity and prospectus types of exclusions. In each case the committee should address their mind to the policy terms and in particular the level of cover provided. Plaintiffs, meanwhile, are seeking larger damages than ever. Until now, the largest settlement of a United States shareholder suit was $3.2 billion. That amount will be dwarfed by the Enron case, even if the litigation is ultimately settled for a fraction of the $60 billion in market value shareholders lost. Enron’s $350 million D&O policy, purchased from eight different carriers, will almost certainly be exhausted. That means former directors may face devastating claims against their personal assets – and that is if Enron’s D&O insurers pay at all. If the company misrepresented its financial condition when it bought the policy, the insurance companies may refuse to pay the claim.
(vii) Conclusion
Earnings management has become an anathema to regulators, governments and institutional and retail investors. Proposals for reform of the audit process abound. A well qualified audit committee is an essential element of effective governance in today’s listed companies. The audit committee properly constituted and advised can be “an independent, vigilant and capable overseer of corporate management’s preparation of financial statements with outside auditors” without overburdening the members with liability.
The audit committee members should be able to put processes in place to minimise the likelihood of audit failure and, if there is audit failure, to ensure their liability is limited. Concerns about increased liability for audit committee members are justified but, if properly followed, procedures can be established to manage and reduce an audit committee’s existing and future exposure to liability.

Developments in class actions, tort law and any other corporate legal developments of major interest to the corporate sector: presentation to Centre

2005-11-22T09:45:00.000+11:00

Developments in class actions, tort law and any other corporate legal developments of major interest to the corporate sector: presentation to Centre for Corporate Public Affairs - Public Affairs Heads of Function and Senior Practitioners Roundtable
ANDREW LUMSDEN
SHAREHOLDER ACTIVISM
AT GENERAL MEETINGS
Increasingly shareholders seem to be saying that they are no longer content to sit on the sidelines while boards and management run companies. This is a somewhat strange proposition and one that misconceives the function of management in the modern listed public company. Be that as it may it’s a simple fact of our corporate environment and one that needs to be managed. This discontent with passive involvement is in part the cause of, and a result of, the federal government’s moves to give shareholders a non-binding say in the salary packages of executives. But how did it get so far off the tracks and where is it going?
REMUNERATION REPORTING
This reporting season sees the commencement in earnest of non-binding shareholder votes on the remuneration reports of ASX listed companies. From the outset there were concerns about how companies would respond to a vote (even a non-binding one) against the remuneration report.
Interestingly in dealing with the provisions upon which the Australian legislation is based in the UK at GlaxoSmithKline, reports suggest that institutional investor groups which were central to the approval vote failing ultimately acceded to a higher compensation/severance package. This is in preference to the alternative, having the CEO depart, which would have been a significantly worse outcome in terms of the GlaxoSmithKline share price.
How long will it be before an Australian senior executive takes a similar view?
Investors in public companies have a right to full transparency with regard to the remuneration received by the board and by the most senior executives and opportunities for debate and discussion by shareholders of the policies applied by a board in determining remuneration levels. Such shareholder activism is a good thing, but enabling shareholders to vote on a non-binding resolution as a means of demonstrating their disapproval is and will be shown to be fraught with difficulty.
If the vote is non-binding and the members are not intended to have power then its purpose is unclear and potentially misleading. It should be the board of directors not the shareholders that have the authority and responsibility for managing the business of the company. The compensation of executives, while titillating and interesting for others, is part of the day-to-day conduct of a company’s business. Rarely is it significant in the context of overall company finances. Even if you cut the CEO’s salary in half, the effect on shareholder wealth would be very small. However, the decision by senior managers to depart would usually have an enormous impact on value.
Early reports are that this year has seen significant dissent votes. Indeed, recently ASIC has taken an interest in the reporting of remuneration votes in Novogen Limited.
 In this recent case, approximately 70% of the proxy votes submitted in respect of the resolution to approve Novogen’s remuneration report were directed against the resolution. At the AGM, the resolution was carried on a show of hands and no poll was called despite the high dissenting proxy vote. ASIC was concerned that the chairman had failed to call a poll, which ASIC considered was “contrary to the duty of a chairman of a meeting (in the absence of a valid request to do so) to call a poll when it is clear that it would produce a different result from a vote on a show of hands.” The second concern related to the disclosure of the vote. In reporting the results of the meeting, Novogen presented the votes against the resolution as a proportion of the total issued share capital of the company (being 12.5%), rather than as a proportion of the number of votes reflected in proxy forms lodged prior to the meeting, namely 70%. ASIC considered this was inappropriate as it created an entirely different perception of the level of disapproval of the remuneration report.
The Novogen case shows the need to carefully deal with the outcomes of remuneration voting even though the resolutions are non-binding. ASIC believes you ought to explain to shareholders what action, if any, you intend to take in response to a negative vote, even though the vote is non-binding.
ASIC is likely to monitor compliance with and the manner in which the votes are conducted and officially announced. ASIC seem to be saying that it believes companies must take into account the views of shareholders, as expressed through the vote (although technically this is questionable if the vote is truly ‘non-binding’).
In planning for the AGM, you need be aware of, and plan for, the potential ramifications of a vote against the remuneration report. At a minimum you should:
 Communicate with key shareholders ahead of the AGM to ensure that the board is able to address the key concerns of shareholders regarding the company’s executive remuneration policy in a timely manner. This communication may also amount to proxy solicitation.
 Consider how the Board would respond to a ‘no’ vote or a substantial negative vote, including the timing of the response and the manner in which shareholder concerns in relation to executive remuneration will be addressed.

CORPORATE GOVERNANCE SERVICES
Meanwhile a related area is a new industry that is emerging in Australia - corporate governance services. The corporate governance industry is riding a new wave of shareholder activism. Once the preserve of marginalised activists and academic researchers, shareholder activism has morphed into a global business worth $1.3 billion a year, which has permeated the life of most public company executives.
In Australia, Proxy Australia one of Australia's largest providers of proxy-voting research was acquired by the global player, US-based Institutional Shareholder Services. Institutions are increasingly under pressure to use their ownership interest to vote and take a more active role rather than simply selling out of companies they are unhappy with.
There will always be a lot of noise from the corporate governance industry but it’s very difficult to clearly demonstrate that these measures add value either in terms of profitability or increased market value.
One worrying consequence of the industry is that most companies chose to ignore the “comply or explain” flexibility inherent in the ASX Corporate Governance Guidelines, instead, companies feel compelled to comply rather than risk adverse ratings.
WHAT’S CORPORATE GOVERNANCE WORTH?
A recent study by the University of Wollongong’s Sydney Business School, found that firms with “poor” corporate governance standards — non-conformance with the ASX Corporate Governance Guidelines and with significant insider ownership influence — have delivered investors “significantly higher” returns than the stock market over the long term, and better financial performance than other firms. Despite all the noise, might it be that governing well and maximising returns for shareholders are mutually exclusive?
The relationship between performance and governance has been the subject of considerable scholarship in the United States for example Paul Gompers, Joy Ishii, and Andrew Metrick, which supported the proposition that there is a link between corporate governance quality and share price performance and valuation there has been little real scholarship on the matter in this jurisdiction.
That said it is probably wrong, and certainly too late to argue against improving standards of governance as such. The nature of governance is different from performance and in reality; good governance is probably less about performance enhancement and more about catastrophe prevention and has much to commend it if executed in a meaningful and thoughtful way.
TRADE UNIONS, MEETINGS AND THE CORPORATIONS ACT
Protest marchers, strikes and demos. They're the traditional face of trade union activism. But proxy votes and meeting requisitions joined the picket line as a union weapon. More and more, union leaders and delegates are speaking out at company meetings as well as stop work meetings. Australian unions are utilising their individual (though usually not their collective) power as shareholders to pursue employee interests.
 In March 2000, the industrial dispute about the move to individual contracts the between the Construction Forestry Mining and Energy Union (CFMEU) and Rio Tinto entered a new phase when the CFMEU launched a proxy campaign against the mining giant. The campaign brought together unions in England, the US and Australia, in an unprecedented global show of shareholder activism. The union moved two shareholder resolutions which one on corporate governance and one was on employment policies, basically saying that the company should respect international human rights standards in the workplace. The vote on the governance resolution was over 20% and over 17% on the employment resolution.
 Commonwealth Bank AGM’s the former Chief Executive David Murray was routinely peppered by the Financial Sector Union (FSU) with questions about plans to retrench “thousands of workers” or to ”close branches”.
 NRMA patrol officers and Australian Manufacturing Workers Union (AMWU) activists sought to hold a meeting to vote on their conditions of employment through proposed amendments the company's constitution. The NSW Supreme Court rejected the NRMA challenge. Trying to avoid a special meeting that might cost NRMA members $4.8 million to stage, NRMA appealed. However, the appeal was unsuccessful. After negotiations with the AMWU NRMA was forced to modify its proposals to restructure the working conditions of insistence on contracting out; for patrol officers.
These are not one off matters, unions have become increasingly willing to utilise various provisions contained in the Corporations Act 2001 as a new forum for advancing employee interests, Ansett and James Hardie are outriders but they are not one-offs.
You should expect that shareholder activism will be employed with increasing frequency by unions. In comparison with the United States union shareholder activism in Australia is in its infancy. It’s worth remembering that America's peak union body, the AFL-CIO, has had an Office of Investments since the early nineties. It drafts hundreds of resolutions for company meetings, as well as providing detailed advice to pension funds and big fund managers about how to vote on boardroom proposals.
In a similar vein, earlier this week the chair of IAG James Strong tried to stop a meeting of shareholders being high jacked by the smash repairers, despite his protestations that issue and other operational matters should not take up shareholders' time, several smash repairers ignored him and took to the microphones. They persisted with questions and statements about the impact of the system, claiming it was damaging their businesses, IAG's brand name and disadvantaging customers, and was the story in the business pages about IAG’s ability to achieve higher profit margins, how IAG made a record $760 million profit or the 4.5c uplift in the dividend per share to 26.5c? No it was about how the angry protesters had upset the meeting and full details of their claims against IAG.
LITIGATION
The growth of shareholder activism and the growing public interest in board accountability will have an impact on the all types of corporate transactions. In this heightened environment of shareholder activism the shareholder class action has emerged as a new element in the life of corporate Australian corporates need to understand class action litigation as a new element of the shareholder landscape.
The class action, is a private remedy designed to allow individual shareholders to come together to try to access justice in a way that leads to a, hopefully, more efficient use of judicial resources. When investors think things have gone wrong, they may to use class actions to bind together and look for someone to blame using a range of legal avenues available to them.
Some recent examples of this include:
 In 1999, GIO, its directors and an independent adviser were sued by Mr King on behalf of 68,000 shareholders who did not accept a takeover offer by AMP as a result of misleading statements in the Part B document. Shareholders settled their proceedings for $112 million. Clearly, the day has arrived when shareholder class actions can be successfully prosecuted in Australian M&A transactions.
 Sons of Gwalia litigation where a shareholder class action is proceeding against the company based on a claim that the company engaged in misleading and deceptive conduct by failing to fully disclose its gold hedging commitments. That litigation is reportedly being funded by IMF (Australia) Limited, a publicly listed company providing funding of legal claims and other related services.
At least two litigation funders are listed on the Australian Stock Exchange (IMF Australia Ltd and Hillcrest Litigation Services Ltd). Although the terms of exch deal are bespoke funding in broad terms is provided on the basis that they take something like 25–40% of the proceeds of litigation and that the funder pays any adverse costs order.
Unlike the position in the United States, preliminary processes designed to strike out unmeritorious claims have been largely unsuccessful. One reason for this is that Australian courts have had a pretty liberal attitude to plaintiffs to allow them access to justice. What this means in practice is more cost, more appearances and an endless stream of hearings into preliminary matters.
TORT LAW REFORM
As a result of a growing community perception that the law of negligence was unclear and unpredictable, that in recent times it had become too easy for plaintiffs in personal injury cases to establish liability for negligence on the part of defendants, and that damages awards in personal injuries cases were frequently too high. A series of intergovernmental responses resulted in the Ipp Review.
The Ipp Review was asked to look at methods that limit ‘liability and quantum of damages arising from personal injury and death’. A key element in the Ipp Review’s approach was that reform should be principle based—that is to say that the changes in the law should encompass ‘general rules governing as many types of cases and as many categories of potential defendants as is reasonably possible’. This is to try to avoid forum shopping.
The review was in part the result of a campaign conducted in the newspapers about cases like:
 Kevin Presland: the actual decision was fortunately reversed on appeal but this was about a fellow with a self-inflicted head injury. He was later referred as a voluntary mental patient to the James Fletcher Hospital. He was released and then went home with his brother. He became psychotic and attacked his brother’s fiancée, violently murdering her. He was found not guilty by reason of that mental illness. He then sued the Hunter Area Health Service, claiming they had a duty to detain him under the mental health act, and that by releasing him they should compensate him for the pain and suffering occasioned by his murdering his brother’s fiancée and his incarceration. The court agreed and awarded him $225,000 for pain and suffering and another $85,000 for lost earnings.
 Guy Swain: the High Court upheld a jury’s decision to award $3.75 million in damages to a plaintiff who was injured whilst swimming at Bondi beach. In this case Guy Swain became a quadriplegic as a result of hitting a sandbar while swimming between the flags at the beach in 1997. Swain sued Waverley Council, alleging that it was negligent in its placement of the flags on the beach on the day of his accident and for not warning of the dangers of the sandbar.
 The pork chop case: a patron in a hotel strapped a pair of pork chops to his feet and began moving about the hotel. When the chops broke apart, other patrons picked up the meaty bits and threw them around. Then the hilarity stopped. Another patron, Troy Boron, slipped on the grease trail left by the chops and broke his arm. Boron was awarded $60,000 in damages after the District Court found the hotel had breached its duty of care by failing to clean the area that the patron had made slippery from his pork-fashioned footwear.
The Ipp Review looked at the standard of care which has always been connected with foreseeability ie if a risk is not ‘far fetched or fanciful’. Ipp recommended changes to this rule that only risks held to be ‘not insignificant’ should be regarded as being foreseeable. This has now been incorporated in the law in the various states and territories.
In the area of negligence the review introduced a new test, based on the Bolam test, a UK principle, which held that a doctor could not be held to have acted negligently if the treatment provided was in accordance with an opinion widely held by a significant number of respected practitioners in the field, unless the court considered that the opinion was irrational.
The Ipp reforms have been implemented by the states and territories, key reforms enacted included proportionate liability for pure economic loss; and comprehensive reform of the law of negligence, including clarifying duties of care, provision for waivers allowing people to accept responsibility for participation in risky activities, protection of volunteers and good Samaritans from the risk of being sued, caps on general damages claims and claims for loss of earnings. These changes have had the effect of significantly limiting the amount of compensation that can be claimed by injured persons.
Part of the objective of tort law reform was to make general insurance more affordable. The latest results on the affordability of insurance showed that public liability insurance premiums have fallen by between four and nearly five per cent.
CSR, NOT SUGAR AND NOT VERY SWEET!
There was a time when the initials CSR meant only one thing: Colonial Sugar Refinery, but not anymore! Questions of CSR (corporate social responsibility) have been referred to the Corporations and Markets Advisory Committee for consideration and advice. Simultaneously, the Parliamentary Joint Committee on Corporations and Financial Services is conducting an inquiry into Corporate Responsibility and Triple-Bottom-Line reporting, for incorporated entities in Australia.
Reflecting these concerns, the Australian Financial Review has editorialised that:
Modern capitalism has many strengths but one big weakness. Some executives are so driven to achieve legitimate corporate goals bigger profits, more shareholder value, a critical restructuring that they are able to justify any technically legal means of pursuing them. The risk is that management and board lose sight of a fundamental question: is this just?
In the vast majority of cases managers’ duty to their company and the law are not in conflict and society as a whole benefits from the wealth created. In rare cases, what is legal and what is just are at such odds that strict legal justifications crumble before community outrage and the threat of legislative action.
In recent times there have been growing calls for Australian corporate regulation to reflect ‘modern business needs and wider expectations of responsible business behaviour’? Not long after these phrases start getting used people start to using terminology like “CSR and “stakeholder” terms that are more likely to confuse than clarify. As Bill Beerworth recently noted:
The term “stakeholder” is itself vague and suggests that anyone identifiable as such has an interest worthy of protection.
Similarly, the phrase “corporate social responsibility” implies that corporations are not socially responsible and that they must be forced to become socially responsible.
Increased community calls for some form of corporate social responsibility cannot be ignored, after all these are the ‘cultural norms’ that shape the way corporations are allowed to operate.
In Canada a significant number of Canadians, and a significant percentage of Canadian shareholders, have been found to want business executives of corporations "to take into account the impact their decisions have on employees, local communities and the country as well as making profit," but can they do so if it at the expense of making profit, when can managers deviate from shareholder wealth maximisation?
In Australia some shareholder advocates have suggested that corporate social responsibility or similar is an attraction to shareholders and potential investors and should be supported by managers without qualification for that reason alone. However, recent research suggests that the belief that corporate social responsibility favourably drives community views of a corporation may be wrong.
The surveys seem to show that “corporate citizenship” in whatever form is less important in driving opinions than more traditional issues such as an open and transparent operation, making profits for owners and shareholders and management/leadership strength. Shareholders do not seem to rate highly support for things like sponsoring events of community interest or being a good corporate citizen whatever benefits may enure to the community. Yet when Australian companies donate millions of shareholder dollars to supporting tsunami appeals the protest is at best muted, generally there is a feeling that::
After all can anybody put a value on the impact on a corporate's image (carefully nurtured these days) from being seen to be tight-fisted or stingy?
The anecdotal evidence suggests that the community has a higher expectation of our managers than a simple responsibility for wealth accretion. As with matters of governance more generally the community seems to expect mangers to focus on the ‘vibe’ of the law as well as the letter.
In the community’s mind we seem to be able to see a blending of views, managers must remain focused on maximising the wealth of their shareholders. However, the obligation to maximise profits does not replace the ethics of honesty and competence or of compliance with the thrust of laws regulating our community even if they do not achieve short term wealth accumulation objectives, in some sense the problem is about short versus long term interests of corporations.
There is another aspect to the issue, that is the rise of the socially responsible investor, at some point you can expect directors to take more notice if favour more socially responsible competitors. As a general rule most Australian managers and their advisers favour shareholder primacy, ie the primary goal of management is to maximise shareholder wealth.
In the UK there has recently been new provisions suggested making clear that directors have to act in the interests of shareholders, but also need to pay regard to the longer term, the interests of employees, suppliers, consumers and the environment. Without going into a forensic examination of the legislation, at a macro level the worry with these types of provisions is twofold:
 Firstly, that the CSR debate raises expectations beyond what can be sensibly delivered, that managers are hoisted on a CSR petard.
 Secondly, that it could lead to greater uncertainty and more capacity for people with only a tangential interest in the company to sue mangers for failing to sufficiently consider their interest or more likely the interests they purport to represent.
Is it really necessary to legislate for CSR? Can you? Australian corporates play a broad role in our society. They do more than simply produce shareholder wealth ,as part of that process they try to keep their workforce safe and happy and they provide their customers with goods or services that bring them back wanting more.
Every day all around Australia the managers of Australian companies, large and small, consider the broader community however; whether companies can or should be made to be responsible for producing positive social and environmental outcomes (the traditional role of governments) is quite another issue.
Andrew Lumsden
Partner
+61 2 9210 6385
andrew.lumsden@corrs.com.au

2005-11-22T09:43:00.000+11:00

Corporate Social Responsibility: the case for a self regulatory model

Andrew Lumsden Corporate Advisory Partner, Corrs Chambers Westgarth

The limited liability corporation is one of the greatest inventions of all time. The corporation is an integral part of our society yet it would seem that society is raising some pretty challenging questions about the role of the corporation in our society. Is there is a need to find a way to enable corporate managers to abandon rules designed in the 1800’s in favour of a more modern concept that recognises the wider role of corporations in our community?

Recently, the Parliamentary Secretary to the Commonwealth Treasurer, the Hon Chris Pearce MP, referred the question of corporate social responsibility to the Corporations and Markets Advisory Committee for consideration and advice. Reflecting these concerns, the Australian Financial Review has editorialised that: “Modern capitalism has many strengths but one big weakness. Some executives are so driven to achieve legitimate corporate goals bigger profits, more shareholder value, a critical restructuring that they are able to justify any technically legal means of pursuing them. The risk is that management and board lose sight of a fundamental question: is this just? In the vast majority of cases their duty to the company and the law is not in conflict with any wider duty, and society as a whole benefits from the wealth created. In rare cases, what is legal and what is just are at such odds that strict legal justifications crumble before community outrage and the threat of legislative action.

In part this is a response the report the Special Commission of Inquiry into the circumstance surrounding James Hardie’s corporate reconstruction. Interestingly, in March 2005, James Hardie’s chair, Meredith Hellicar, called for: “a safe harbour for directors to be able to integrate corporate social responsibility into their decision making without fear that they are going to be sued both personally, and as a company, by their shareholders. “.

To what extent is this concern real? Does Australian corporate regulation need to reflect ‘modern business needs and wider expectations of responsible business behaviour’, that ‘the basic goal for directors should be the success of the company for the benefit of its members as a whole’ and that to reach this goal, directors should be able to ‘take a properly balanced view of the implications of decisions over time and foster effective relationships with employees, customers and suppliers, and in the community more widely’?

There is advantage in providing a reasonable level of protection for those that want to take the ‘long view’. However, many commentators believe that the existing duties of managers, especially the overriding duty to act in the best interests of the company, already accommodate consideration of wider interests by directors and officers if the decision is justifiable as being in the company’s best interests.

Yet, it seems that managers have concerns about how to take a properly balanced view of the implications of their decisions as well as foster effective relationships with employees, customers and suppliers, and the community more widely, whilst at the same time not leave themselves open to complaint from shareholders.

The increased community calls for some form of corporate social responsibility cannot simply be ignored; these are the ‘cultural norms’ that shape the way corporations are allowed to operate. In Canada a significant number of Canadians, and a significant percentage of Canadian shareholders, have been found to want business executives of corporations "to take into account the impact their decisions have on employees, local communities and the country as well as making profit," but can they do so if it at the expense of making profit?

To simply introduce provisions such as those suggested in the UK could lead to greater uncertainty and more capacity for people with only a tangential interest in the company to sue mangers for failing to sufficiently consider their interest or more likely the interests they purport to represent.

The question of whether such a provision is strictly necessary can be avoided by simply including a replaceable rule that will give managers some comfort if they prefer the long view over the short.

The use of a default provision of the constitution giving the managers the freedom to include matters such as employees, customers and suppliers, and the community as being in the interest of the company should provide managers with some comfort.

Time for the Corporations Act to include a new replaceable rule?

Self regulation is appropriate for complex and difficult issues like corporate social responsibility that do not necessarily require an industry wide solution. A self regulatory model allows a solution tailored to each entity’s circumstances. If there was genuine community agreement about the value of corporate ethics then such provisions affirming their place in the life of the company would quickly gain acceptance as best practice.

Is it necessary for corporate social responsibility to be enforceable? Probably not, as calls for corporate social responsibility have largely been along the lines of the need for a permissive model so, to this extent then there would seem to be no basis for criticising a self-regulation model on the basis of enforcement difficulties.

A self regulatory model will also ensure that only those companies with a genuine interest/need take the issue forward and this is less likely to result in an approach to corporate social responsibility that is a process focussed “tick the box” approach.

A replaceable rule also provides flexibility providing scope for efficiency improvements and innovation. Additionally, such a rule would recognise that many small and micro businesses use the corporate form and do not have the resources to comply with a prescriptive set of rules.

The corporation is create of statute designed for investors to collect together for a common business pursuit through a legal entity that provided the benefits of limited liability, continuity of existence and simplicity in contractual dealings. As part of the bargain, investors should be able to regulate the general nature of their bargain with the other investors and management through the constitution.

The Corporations Act provisions dealing with the constitution could have a default setting that provided that in the absence of an alternative provision in the constitution of a company the board as the agent of the investors were entitled have regard to their a social responsibility the board would be entitled to do more than adhere to the rules and doing “whatever you can get away with”.

The provision would thus form part of the contract between the members and management and it would be theirs to consider, modify if necessary and reject if they wished. It would not be open to regulators, “stakeholders” or anyone who was not a member or officer to enforce against mangers.

A replaceable rule would also lessen the risk of litigation against the corporation by tangential ‘stakeholders’. A statutory proscription to consider social issues, could mean that section 1324 of the Corporations Act could be used to enable the “stakeholders” to seek remedies against managers for not having, say, proper regard to “the community and the environment”. Whilst little use has been made of this provision in developing the view that officers might owe duties to others in addition to their company that is not to say it could not be. The future battle ground for lawyers looking for ways of representing people like the landholders surrounding the BHP mine in Papua New Guinea, Ok Tedi, might be based around the injunction and corporate social responsibility provisions.

In practice, a constitutional provision of this type would not fundamentally alter the circumstances where a board had somehow failed to properly consider, corporate social responsibility type matters in circumstances where it would have been in the best interests of the company to do so. Those directors would still be liable for failing to satisfy their duty of care and diligence. However, if the directors had taken a decision favouring the long term sustainability of the company which resulted in financial detriment to the current shareholders the directors could argue the existence of the replaceable rule was a relevant factor in determining the ‘corporation’s circumstance’ or the office held and the ‘responsibilities within the in the corporation’.

A replaceable rule would also be consistent with the Principle 10 of the ASX recommendations. Compliance with this recommendation was originally contemplated by a code of conduct but a replaceable rule would be entirely consistent with the recommendation. A replaceable rule would also give managers more certainty than a code of conduct, in terms of their duties to the company and the availability of business judgement defences.

An interesting related development might include combining accreditation and self-regulation. A voluntary accreditation scheme might also be adopted to try to ensure consistencies in corporate social responsibility standards across different sectors. Self-regulation of the type discussed could mean that companies are defining their own corporate social responsibility standards and therefore some entities will be taking on far greater corporate social responsibility obligations than other entities.
As with other corporate governance reforms, a self regulatory approach to corporate social responsibility is the surest way to get meaningful approach to this issue. There is a case for reforming directors and officers’ duties; the changes needed should not be revolutionary. A self regulatory model together with a scheme for accreditation provides a better model for influencing behaviour by institutionalising a change that is permissive and reflective of each company’s own circumstances.

If the social norm has shifted, and there is ample evidence it has, then that pressure can be accommodated in the proposed model. The self regulatory model suggested will allow company’s to create wealth on a sustainable basis, but subject to the requirements of responsible business conduct.

Sources: Letter of referral by The Hon Chris Pearce MP to CAMAC, available at http://www.camac.gov.au/CAMAC/camac.nsf/byHeadline/Whats+NewDirectors%27+duties+and+corporate+social+responsibility?openDocument; Parliamentary inquiry into Corporate Responsibility, see online at http://www.aph.gov.au/Senate/committee/corporations_ctte/corporate_responsibility/index.htm; AFR article 22 September 2004, pg 62; UK White Paper on Modernising Company Law available on the UK Department of Trade and Industry's website at http://www.dti.gov.uk/cld/WhitePaper.htm; James McConvill “Directors’ duties to stakeholders: A reform proposal based on three false assumptions” (2005) 18 Australian Journal of Corporate Law 88, see also - Ian Ramsay, ‘Pushing the Limit for Directors’, The Australian Financial Review, 5 April 2005, 63; R. Baxt, “Directors’ Duty of Care and the New Business Judgment Rule in the 21st Century Environment”, Seminar Paper, Seminar on Key Developments in Corporate Law & Equity, Melbourne, March 2001 cited in Saul Fridman “Corporations Law in the courts and the academy: a dangerous malaise?” Butterworths Corporation Law Bulletin No 23 December 1996; ASX Principles of Good Corporate Governance and Best Practice Recommendations.

Disney and the shareholders

2005-02-25T14:41:00.000+11:00

The courtroom battles between shareholders and directors are seldom the stuff of “Vanity Fair” magazine. However, if the subject matter is the Disney company, the directors include Sydney Poitier and the matter revolves around the tale of two Hollywood titans, then expect the unusual.
Shareholders of Disney are claiming against the Disney directors and the compensation committee in particular for their role in the employment and severance agreements of former president Michael Ovitz.[1] The compensation committee approved the dismissal of the president and the payment of a US$140 million severance package after Mr Ovitz was less than 15 months in the job.
The recently concluded trial, and the SEC orders (settling inadequate "related party transaction" disclosure issues), are part of a continuum for the Walt Disney Company that included a very difficult shareholder meeting in 2004 that resulted in the board separating the positions of chairman and chief executive. Last year, nearly 45% of shareholders voted against CEO Michael Eisner's re-election to the board. In response, the board stripped Eisner of his role as chair and elevated former U.S. Senator George Mitchell to that post. Eisner later announced that he would retire by September 2006.
This case is interesting because it examines a claim around excessive compensation for people other than interested directors in question and because the case explores the duty of directors and directors on the remuneration committee in particular, to act in good faith.
The US and Australian formulations of the business judgment rule provide that directors have the right and duty to decide where the company's interests lie. Directors are entitled to have regard to a wide range of practical considerations and their judgment is not open to review in the courts.[2]
It is a prerequisite of the business judgment rule[3] that directors have acted in good faith[4] and for a proper purpose. The elements of the rule are good faith, disinterest, exercise of judgment, proper information and reasonable belief. Thus, although the board of directors is entitled to a presumption that it exercised proper business judgment, the board will need to be able to demonstrate:
§ the decision was made in good faith and for a proper purpose (ie in the best interests of the corporation as a whole);
§ they had no material personal interest in the matter;[5]
§ they informed themselves of available material information by, for example:
§ considering an appropriately selected expert’s opinion;
§ providing all board members with adequate and timely notice of the matter , of its purpose and all relevant information for the purpose of considering the transaction; and
§ inquiring adequately into the reasons for, or terms of, the transaction.
The duty of good faith requires that directors must: exercise their powers in the interests of the company, not misuse or abuse their power, avoid conflict between their personal interests and those of the company, not take advantage of their position to make secret profits, account to the company for business opportunities which come to them by reason of or in the course of holding office as a director and exercise an independent judgment in relation to proposals put before the board.[6]
Executive compensation (as opposed to that of directors) is a matter of business judgment. Good corporate governance requires that boards take responsibility for the remuneration of the business’ key executives.[7] In the US it has been suggested that if directors say that they base compensation decisions on some performance measure and then don't do so, or if they are disingenuous or dishonest about it, this could amount a breach of the directors duty of good faith.[8]
The question is what type of conduct must a director engage in to be found to have not acted in good faith and thereby allow a court to review the board (or the committee’s) business judgment? Courts have traditionally had some difficulty in divining the subjective motivation (good faith or bad faith) of officers from objective facts; generally conduct must be fairly egregious in order to rise to the level of "bad faith".
The standard of behaviour required is not complied with by subjective good faith or by a mere belief by a director that his or her purpose was proper, rather it involves a determination of whether a reasonable director could have reached that conclusion.[9]
In the first Disney case the Court refused to dismiss a complaint seeking to hold the directors of The Walt Disney Company personally liable for damages arising out of the hiring and termination of Michael Ovitz as Disney's President. The complaint suggested complete abdication of authority by the directors. It was alleged that, when Ovitz was hired, the compensation committee and the directors paid little attention to the terms of his employment, leaving the arrangements to be negotiated by Mr. Ovitz and his "close friend," Michael Eisner, Disney's Chief Executive Officer.[10]
The board's alleged neglect will be key to the Court's decision. While the business judgment rule might have applied if "the board had taken the time or effort to review [its] options, perhaps with the assistance of expert legal advisors," the allegations, if found made out, "imply that the defendant directors knew that they were making material decisions without adequate information and without adequate deliberation, and that they simply did not care if the decisions caused the corporation and its stockholders to suffer injury or loss."
The duty of good faith requires that a director act in the best interests of the corporation. While the Court's review requires it to examine the board's subjective motivation, the Court will utilise objective facts to infer such motivation. The analysis will focus on the process by which the board reached the decision under review. That said however, Australian courts are likely to remain extremely reluctant to impose liability on disinterested directors who make genuine efforts to fulfil their duty to make informed decisions regarding matters of importance like executive compensation.[11]
The good faith obligation includes an obligation to penetrate beyond the superficial whilst this is a more onerous obligation than that held by a director generally because a specific responsibility has been assigned to the committee it is consistent with the obligation to exercise a level of care and diligence having regard to the circumstances of the director the office held.[12]
In the Australian context the good faith test will probably cross similar ground to the statutory requirement of the business judgment rule that the committee members have informed “themselves about the subject matter of the judgment to the extent they reasonably believe appropriate”,[13] that is, the committee came to an informed decision.
In this context committee members need to be able to establish they conducted themselves in a manner that enabled them to reach an informed business judgement about the remuneration/compensation issue. The committee needs initiative, diligence and independent thought.[14] Unfortunately this might mean a proliferation of external advice designed to protect the members of the committee from liability.
For Disney it will be interesting to see whether without the harsh glare of shareholder criticism the company will maintain its interest in shareholder rights and whether the Delaware court is willing to open the board room door and analysis the appropriateness of the Ovitz termination and employment arrangements.
Remuneration/ compensation committee
Remuneration/compensation committees used to be considered relatively innocuous, but the rules of the game are about to change, if they haven’t already, the Corporations Act[15] now includes specific references to the work of the remuneration committee, if not committee itself. The ASX corporate governance principles[16] recommend the establishment of a remuneration committee the majority of whom should be independent and who should be lead by an independent chair.

The committee will usually be responsible for remuneration policies and practices, it will to take control of the disclosure obligations relating to executive remuneration[17] and the adoption of the remuneration report.[18]
Takeaway – satisfying the business judgment ‘defence
To rely on the business judgment rule members of the remuneration committee need to be able to demonstrate five things:
1. That a decision was taken.[19]
2. No personal interest in the matter that could be seen to have a capacity to influence the individual’s vote.
3. The decision was made for a proper purpose (in the best interests of the company) without misuse or abuse of power and exercising independent judgment.
4. That members reasonably informed themself of all material information concerning the matter by, for example:
§ considering an expert’s opinion;
§ adequate and timely notice of the to allow proper consideration of the matter; and
§ demonstrate inquiry.
5. That members rationally believe the decision is in the best interests of the company.
In general a systematic approach to the transaction will help committee members substantiate that they took reasonable steps to inform themselves and that their belief that the transaction was in the best interests of the company was reasonable.
∞ *This is an edited version of an article that appeared in CCH’s "Across the Board".
[1] In re The Walt Disney Company Derivative Litigation, C.A. No. 15452, Chandler, C. (Del. Ch. May 28, 2003) discussed in John F. Grossbauer Nancy N. Waterman The (No Longer) Overlooked
Duty Of Good Faith Under Delaware Law available at http://www.pacdelaware.com/publications/corporate/good_faith_duty.html for more details of the case and the claim see The battle for Walt Disney 30 November 2004 available at http://www.crikey.com.au/business/2004/11/30-0006.html
[2] Harlowe's Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL (1968) 121 CLR 483 at 493
[3] Contained in s 180(2). The statutory business judgment rule only operates in respect of the statutory duty of care and diligence (s 181(1)) and the equivalent duties at common law and in equity. However, there is also common law business judgment rule which applies generally to judgments of directors, in each case good faith is an absolute requirement to the benefit of the ‘safe harbour.’ See Ford, Austin & Ramsay Ford's Principles of Corporations at [8.060].
[4] That is, not in breach of s 181.
[5] See Murray J in McGellin v Mount King Mining (1998) 144 FLR 299 holding that relationship needs to be of some real substance to the matter and a consideration of the contract or arrangement that is proposed.
[6] Chew v R (1991) 5 ACSR 473 at 499, Blackwell v Moray (1991) 9 ACLC 924, Ring v Sutton (1980) 5 ACLR 546
[7] A Lumsden “CLERP 9: Confusing the Proper Role of Boards and Shareholders”, November 2003 available at http://www.corrs.com.au/corrs/website/web.nsf/Content/Pub_01106S_Paper_CA_251103_CLERP_9_Confusing_the_Proper_Role_of_Boards_and_Shareholders
[8] Jerry Useem, Overpaid CEOS? Try Suing the Paymasters, Fortune (Dec. 19, 2002)
[9] See ASIC v Adler (2002) 41 ACSR 72 at pg 234 this is also made clear by the new provisions in s 184(1) which imposes the additional elements of being “intentionally dishonest” or “reckless” for the purpose of criminal sanctions. Thus, as was said by Bowen LJ in Hutton v West Cork Railway Co (1883) 23 Ch D 654 at 671:
Bona fides cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying its money with both hands in a manner perfectly bona fide yet perfectly irrational.
[10] The complaint alleged that the Compensation Committee and the Board both failed to review any drafts of the employment agreement, spent very little time considering the arrangements and neglected to obtain expert advice on the terms granted to Mr. Ovitz.
[11]
[12] Section 180(1)(b). This is consistent with Greaves Case a case arising out of the collapse of One.Tel. The court took into account the roles held by John Greaves as chair of the One.Tel board and chair of the audit committee, when assessing the scope of the legal duties that Greaves owed to One.Tel. This is the first sign of a willingness of Australian courts to adopt the type of reasoning US courts have used in respect of directors on audit committees.
[13] Section 180(2)(c).
[14] For an interesting example of where this didn’t occur see Report Of Investigation By The Special Committee Of The Board Of Directors Of Hollinger International Inc. Gordon A. Paris, Chairman, Graham W. Savage, Raymond G.H. Seitz, Counsel and Advisors Richard C. Breeden & Co., The Law Offices of Richard C. Breeden Counsel O’Melveny & Myers LLP - August 30, 2004 available at http://www.sec.gov/Archives/edgar/data/868512/000095012304010413/y01437exv99w2.htm see pg 493-507.
[15] Sections 300A, 250R and 250SA
[16]ASX Corporate Governance Council, Principles of Good Corporate Governance and Best Practice Recommendations, Recommendation 9.1 and 9.2.
[17] Section 300A.
[18] Sections 250R and 250SA contain detailed provisions regarding the process for putting the remuneration report to members.
[19] One key element of the “business judgment” is that a decision must have been consciously made and judgment must, in fact, have been exercised. While a business decision may involve a judgment either to act or to abstain from action. If, for example, directors have failed to oversee the conduct of the corporation's business by not considering the need for an effective audit process, and this permits an executive to abscond with corporate funds, business judgment rule will not operate at al: see ASIC v Adler (2002) 41 ACSR 72 at pg 181.

A trip to the roof of the world

2005-02-25T14:39:00.000+11:00

I'm not sure what prompted me to want to visit Tibet, none of the traditional reasons for selection of a travel destination applied. No one I knew had been there before, the crew from Getaway hadn't covered it (or at least not during my viewing) and at the time none of the recent movies about Tibet had been released. Maybe it was a dim and distant memory of Lost Horizon that sent me in search of Shangri-La the mysterious Buddhist land.
I arrived in the Land of Snows from Kathmandu, Nepal. Flying across the Himalayas into Tibet must be one of the most exiting flights in the world, Everest is clearly visible from window of the plane and seems to be about the same height as the plane's cruising altitude. After arriving at the newly constructed Gonggar airport and getting used to the altitude (3,600m or so) there's the small matter of getting to Lhasa, 95 kilometres (2 hours) from the airport. A group of travellers I'd never met and I banded together and hired a landcruiser to take us to Lhasa.
Lhasa is one of the most wonderful and exciting cities in the world, since the 7th century this magnificent city has been the centre of religion and government in Tibet. The majestic image of the Potala (the main home of the Dalai Lhamas and the base of Tibetan government before the Chinese invasion) with its enormous white and red white washed walls dominates the city and captivates you from your very first glimpse. Knowing a little of the history of the military invasion, repression and partial destruction of Tibet by the Chinese, for me the Potala also evoked an image of great emptiness and sadness. Despite much encouragement from fellow travellers, during my many days in Lhasa this sadness kept me from visiting what is now no more than a museum to what was once the heart of this magnificent country.
Accommodation in Lhasa is surprisingly good and seems to range across the spectrum with something to suit all tastes. My choice fell to the Yak Hotel (a recommendation from a couple of guys from Hong Kong I met in a bar in Kathmandu - but that's a different story). The Yak is a really lovely hotel filled with exciting people from all over the world eager to share exciting travel stories and to join me in adventures into this exciting land. The altitude (everywhere is at least twice the height of Kosciuszko) takes its toll, particularly in the first few days so it's vital to have accommodation that is comfortable, clean and relaxing.
At the Yak Hotel is CITS Shigatse Travels, a wonderful friendly and helpful bunch who's ‘can do attitude’ was just what an individual traveller with only a 4 weeks to try to explore this huge country wanted to hear.
My first trip was a short pilgrimage to Tsurphu Monastery (4480 metres above sea level according to the ever reliable lonely planet travel survival kit for Tibet). The 70-kilometre journey took a fair bit longer than l thought (6 hours) ... but what a journey. The snow swelled Tsurphu River winds beside the road. The river is a swirling splashing torrent with huge unmelted chunks of snow bobbing in it. High mountain ranges towered on either side. The road is in pretty bad shape and the combination of bad roads, thick mud and less than state of the art mechanics makes for an "interesting" trip.
The Monastery at Tsurphu is magnificent. It is the 17th Karama (a 14 year old boy who is the seventeenth reincarnation a living Buddha). The Tibetans believe that when a lama dies he is reborn and his reincarnation becomes the new lama. The golden roofs, upturned eaves and inscribed stone pillars are set against a back drop of towering snow-capped mountains. My poor photographic skills lived up to my expectations and completely failed to capture the grandeur and beauty of this scene.
My next destination was the lakes at Nam-tso and the Tashi Dor Monastery. The trip to the lake takes the best part of a day so, if your going to have time to explore and get a feel for this magnificent area, then you’d better plan to spend at least three days away from Lhasa. The trip to the lakes is, like all journeys in Tibet a part of the whole experience. Up until the Chinese invasion there were almost no roads. The road winds through the high mountain passes sometimes as high as 5000 metres.
The lake is a wonderful shade of torquise blue and the surrounding mountains are something else. The Monastery sits on a peninsular that juts into the lake. I’d heard the accommodation would be pretty rough and there would be no food available so I arrived well stocked with instant noodles, dried fruit and a thick down sleeping bag.
The journey to and from the lakes takes you past remote expansive plains and looming Mountains. Everywhere you travel you see the nomadic Tibetan people herding small flocks of yak, sheep and goats. While most Tibetans live in small communities growing barley and other crops there are still many nomads who live a lifestyle largely unchanged for centuries.
There is so much to see in this vast and exciting land. The people are warm and friendly and despite their obviously difficult circumstances they go out of their way to make you feel warm and welcome.
The end of my journeys in Tibet took me down the Friendship Highway from Lhasa to the Nepal border. The trip takes in many wonderful cities and villages and is well worth leaving a week or so to travel the 750 kilometres to the border.

I detoured from my journey to the border for a week or so at the Rongbuk Monastery. The monastery sits at the foot of Mt. Everest and its only a short (3 hour) walk to the Mt Everest base camp on the Tibetan side at the foothills of the worlds tallest mountain Qomolangma (the Tibetan name for Everest). The monastery is at 4900 metres so even a short walk can be quite demanding. The sight of Qomolangma is awe-inspiring and you can spend countless hours watching the changing faces of the mountain.
Tibet is a wonderful and exciting land that, despite the difficulties of travel, will reward those who take the trouble to venture inside. Travelling in this land is a small step towards understanding the difficult road ahead for the Tibetan people. The scenery is without parallel. Every day the constant views of the glorious snow capped Himalayas, the intricate pattern of terraced crops stretching along their base and the presence of these beautiful people make you glad to be alive.

I don't care whether it is true: its a good lesson against certainty

2004-08-09T09:03:00.000+10:00

This is the transcript of the ACTUAL radio conversation of a U.S. naval ship with the Canadian authorities off the coast of Newfoundland October 1995. Radio conversation released by the Chief of Naval Operations 10-10-95.

Canadians: Please divert your course 15 degrees to the South to avoid a collision.
Americans: Recommend you divert your course 15 degrees to the North.
Canadians: Negative. You will have to divert your course 15 degrees to the South to avoid a collision.
Americans: This is the Captain of a US Navy ship. I say again, divert YOUR course.
Canadians: No. I say again, you divert YOUR course.
Americans: THIS IS THE AIRCRAFT CARRIER USS LINCOLN. THE SECOND LARGEST SHIP IN THE UNITED STATES ATLANTIC FLEET. WE ARE ACCOMPANIED BY THREE DESTROYERS, THREE CRUISERS AND NUMEROUS SUPPORT VESSELS. I DEMAND THAT YOU CHANGE YOUR COURSE 15 DEGREES NORTH, I SAY AGAIN,THAT'S ONE FIVE DEGREES NORTH, OR COUNTER MEASURES WILL BE UNDERTAKEN TO ENSURE THE SAFETY OF THIS SHIP.
Canadians: We are a lighthouse, your call.