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Avoiding the Storm: the kind of breaches of director’s duties that ASIC eyes

By Caroline James

Where a director breaches his or her duties as prescribed in the Corporations Act 2001 (Cth) (“the Act”), the shareholders of the company are usually the victims, which means that the duty is owed to the company. As a result of this, ASIC will usually prosecute the directors for such breaches if they are brought to ASIC’s attention.

ASIC’s prosecutorial powers also expand to instances of breaches where the interests of the company more broadly are harmed, as was seen in the Federal Court judgment in favour of ASIC as against the directors of Storm Financial.

The Federal Court handed down their judgment on 29 August 2016.

 

The Facts

Since 1994, Mr and Mrs Cassimatis were the directors of the Storm Financial Limited, which was in the business of financial investment advice.

The allegation of breach related to the generic nature of the advice which was not tailored to the needs of individual clients because their model encouraged clients to borrow against their homes and obtain margin loans to invest in index funds. Essentially, clients borrowed against their houses, and then they borrowed some more against the assets they bought with the money they borrowed against their houses. The proceeds were invested in particular shares that were units in index funds, which failed miserably during the global financial crisis.

The issue was that many of the investors were over 50 years old, were retired or reaching retirement, had limited income and assets, and were, from the outset, unlikely to be able to financially recover in the event that significant loss resulted.

ASIC did not allege that the investment model was inappropriate for all investors, but argued that Storm Financial failed to properly investigate the advice given to the elderly investors with limited assets, as it was inappropriate for them to use their homes as security. ASIC also argued that Storm Financial failed to ensure that the financial services covered by its licence were provided efficiently, honestly and fairly.

breach-directors-duties-storm-financial

ASIC’s prosecutorial powers also expand to instances of breaches where the interests of the company more broadly are harmed, as was seen in the Federal Court judgment in favour of ASIC as against the directors of Storm Financial.

The allegation of breach related to section 180 of the Act where there are prescribed requirements on directors for the exercise of their powers and duties; namely, that it be with a degree of care and diligence such that a reasonable person would exercise if they are in the director’s circumstances and had the same responsibilities. As many of you know, that section breaks down what is known as the “business judgment rule”; being the rule by which all directors should follow so as to ensure compliance.

The Finding

Justice Edelman held that Mr and Mrs Cassimatis “used their powers as directors to create an environment in which (as they were aware) it was almost inevitable that the Storm model would be applied to people with a high degree of financial vulnerability.” He concluded that each director contravened section 180(1) of the Act “by exercising their powers in a way which caused or ‘permitted’ (by omission to prevent) inappropriate advice to be given to the relevant investors,” of which reasonable directors in their position would have been aware.

The ruling on remedies and costs will be handed down on 1 February 2017.

Take Home Points

In making his decision, Justice Edelman considered the following helpful points in relation to section 180(1) of the Act:

  • Although many investors suffered, the directors’ actions resulted in only one single contravention by each director (as opposed to multiple contraventions).
  • The Court rejected ASIC’s argument that an actual contravention by Storm Financial was required to establish a breach of section 180(1) by the directors, but was a “stepping stone” for finding a breach by the directors.
  • The duties owed under section 180(1) are owed solely to the company, but the company’s interests are not limited to the interests of the shareholders. In balancing the foreseeable risk of harm against the potential benefits of the directors’ actions, the interests of the company were construed broadly and are not limited to financial loss, neither did they require actual proof of loss. The Court considered that, like individuals, corporations have reputations independent of financial concerns. Furthermore, it is not in the interest of a corporation to engage in unlawful conduct even if the conduct is profitable.
  • A director who is a sole shareholder of a solvent company may still breach section 180(1) as shareholders cannot ratify breaches.

ASIC’s powers to investigate and prosecute

ASIC have the power to investigate directors’ breaches and institute civil or criminal proceedings under various pieces of legislation, including the Act and the Australian Securities and Investments Commission Act 2001 (Cth).

Statistics show that between 1 July and 31 December 2015, ASIC commenced 105 investigations. Of those investigations: 42 criminal charges were laid, 27 individuals were removed from financial services, and 20 infringement notices were issued.

ASIC does not undertake a formal investigation of every matter that is reported to it. Rather, it assesses the seriousness of the alleged misconduct and its market impact, the regulatory benefits of pursuing misconduct, and other matters such as the time since the misconduct occurred, whether it was an isolated instance and whether evidence is available. The Storm Financial case is an example of ASIC taking action because the misconduct affected market integrity and the confidence of investors. It is clear that here ASIC intends sending a message about the consequences of directors giving negligent investment advice.

Members and directors (and former members and former directors) can bring proceedings on behalf of the company. The court may allow this where the company will not itself bring the proceedings or take responsibility, the applicant acts in good faith and it is in the best interests of the company.

ASIC’s focus for 1 January to 30 June 2016 was on market integrity, corporate governance, and financial services.

We will wait with anticipation to see what comes out of its next enforcement report.


If you require legal advice in relation to your duties as a director, or if you wish to enquire of actions of the directors of a company to which you have been dealing with or have shareholdings in, please contact Peter North (Senior Associate, Corporate Practice Group) or John Wardlaw (Principal, Corporate Practice Group) or on 03 9629 9629.