JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED?
The Hon Christopher Steytler QC*
Abstract
This article examines three corporate scandals, namely, James Hardie, NAB and AWB Ltd, and considers what lessons can be learned from them.
I Introduction
There has been no shortage of Australian corporate scandals over the past decade. We have seemingly learned little from them. I have selected three that raise issues that seem to me to be important.
II Three Australian Corporate Scandals
A James Hardie
Two companies, Amaca Pty Ltd and Amaba Pty Ltd (‘Amaca’ and ‘Amaba’ respectively), had, for many years, manufactured asbestos products. Both were large companies. Amaca (formerly known as James Hardie & Coy Pty Ltd) was the largest manufacturer of asbestos products in Australia, holding 70 per cent of the market.1 The two companies were members of the James Hardie Group (‘the Group’). Another large company, James Hardie Industries Ltd (‘JHIL’) was the Group’s ultimate holding company. Amaca and Amaba (formerly Jsekarb Pty Ltd), both wholly owned by JHIL, incurred liabilities in tort to a large number of persons who had suffered asbestos-related injuries as a result of use of the asbestos products manufactured by them. So, too, did JHIL, albeit to a lesser extent.
Between 1998 and 2003 the following transactions were entered into by the Group.
* Former Justice of the Supreme Court of Western Australia; Parliamentary Inspector of the Corruption and Crime Commission of Western Australia; Professor of Law, University of Western Australia. 1 New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation (2004) Annexure J Vol 2, 121.
123 (2010) 12 UNDALR The Group set up a trust fund (‘the Fund’), named the Medical Research and Compensation Foundation, to engage in medical research and to provide compensation for asbestos victims. The Fund was administered by a newly created trustee, Medical Research and Compensation Foundation Ltd (‘MRCFL’). The board of JHIL then made a gift of its shares in Amaca and Amaba to MRCFL in its capacity as trustee of the Fund. The Fund consisted of an amount calculated by reference to the total assets of Amaca and Amaba plus an additional amount of $3 million provided by JHIL (to be spent on medical research). The total amount was described by the directors in the Group as exceeding the ‘Best Estimate’ contained in an actuarial report dated 13 February 2001 that had been prepared by Trowbridge Deloitte Ltd.2
Amaca and Amaba were, in this way, effectively ejected from the Group and isolated into MRCFL. A few months later JHIL was also ejected from the Group. The Fund was the only source of compensation for asbestos victims who had brought claims against the two companies.
The Fund proved to be far too small, having regard to the number of asbestos victims and the extent of their claims. A Commission of Inquiry was set up to investigate the transactions that had led to the setting up of MRCFL and the creation of the Fund. This was the Special Commission of Inquiry into the Medical Research and Compensation Foundation, conducted by Commissioner David Jackson QC (‘Inquiry’).3
Commissioner Jackson found that the actuarial report ‘provided no satisfactory basis for an assertion that the Foundation would have sufficient funds to meet all future claims’.4 The Commissioner concluded that the provision made by the Fund was the smallest amount thought by the controlling directors of the Group to be ‘marketable’.5 Commissioner Jackson also found, from board papers ultimately produced by the Group, that the Group had embarked upon a deliberate ‘communications strategy’ designed to attract as little attention as possible and to minimise the prospect of government intervention.6
2 See, New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1, Vol 1, 9, [1.9]-[1.10]; Australian Securities and Investments Commission v Macdonald (No 11) (2009) 256 ALR 199. 3 New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1. 4 New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1, Vol 1, 9, [1.9]-[1.10]. 5 New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1, Vol 1, 13, [1.25]. 6 New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1, Vol 2, Annexure K.
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It was only towards the very end of the hearing of the Inquiry that the Group offered to compensate all asbestos victims to whom former companies in the Group were liable. This led, ultimately, to an agreement between the Group and the State Government of New South Wales, entered into in December 2005.7
Since then, a number of former directors and senior executives of JHIL (including its general legal counsel) have been found by the Supreme Court of New South Wales in Australian Securities and Investments Commission v Macdonald (No 11)8 to have breached duties under the Corporations Act 2001 (Cth) arising out of events surrounding these transactions. [Since the time of writing this article, this decision has been overturned by the Court of Appeal in New South Wales: James Hardie Industries NV v Australian Securities and Investments Commission [2010] NSWCA 332 (17 December 2010).]
B The NAB Foreign Exchange Dealers Scandal
In 2003-4, unauthorised trades were effected by four dealers at the foreign exchange options desk of the National Australia Bank (‘NAB’). These resulted in losses to the NAB totalling $360 million.
The four traders, Luke Duffy (the head of the foreign exchange desk), David Bullen, Gianni Gray and Vince Ficarra, were young men at the time of the trades, having been 34, 31, 34 and 24 years old respectively and supervised by Gary Dillon, a Joint Head of the NAB’s Global Foreign Exchange Division. They had begun concealing trading losses in September 2001, and possibly earlier. At first, by using incorrect dealing rates for genuine transactions, the traders shifted profits and losses from one day to another (a process described as ‘smoothing’). Later, in order to conceal trading losses, they processed false spot foreign exchange and false currency option transactions. They had discovered a ‘one-hour window’ between 8.00am, when the ‘end-of-day procedure’ (known as ‘Horizon’) was run (this formed the basis for profits and losses in NAB’s general ledger, from which financial reports were prepared), and 9.00am, when NAB’s Operations Division began checking the previous day’s transactions. During this window, the traders would amend the incorrect deal rates and reverse the false transactions in the Horizon so as to prevent detection of what they had done.9
7 See generally, Peta Spender, ‘Weapons of Mass Dispassion’ (2005) 14 Griffith Law Review 280. 8 (2009) 256 ALR 199 [1269], [1285], [1287], [1271]. 9 See generally, Report by PricewaterhouseCoopers, Investigation into Foreign Exchange Losses at the National Australia Bank, 12 March 2004 (‘PwC report’) 1, 2.
125 (2010) 12 UNDALR In October 2003, Mr Duffy told junior staff in the Operations Division that they need no longer check internal transactions. They stopped doing so, without telling their managers. This enabled the traders to record false one-sided internal options transactions which were ‘surrendered’ before maturity so as to avoid discovery of the deception at the time when there would otherwise have been a cash settlement.10
The currency options desk’s losses increased after 1 September 2003. As a consequence, exposures grew larger and riskier. Although the traders were able to partly obscure the position by utilising false option transactions, many breaches of limits were identified, reported and approved. The number of breaches grew significantly in late 2003 and in January 2004.11
The losses were discovered in January 2004. Inquiries into the trades were carried out by the Australian Prudential Regulatory Authority (‘APRA’) and by PricewaterhouseCoopers (commissioned by NAB). Both prepared reports suggesting three principal reasons for what had taken place.12 These were a lack of integrity on the part of the dealers, an inappropriate risk control framework and too strong a focus on profit.
The NAB’s risk control framework was found by PricewaterhouseCoopers to have been deficient in four principal respects. Two of these are that:
(1) There was inadequate supervision of the traders. The PricewaterhouseCoopers report (‘PwC Report’) found that ‘the Traders took large, complex and risky positions, while supervision was limited to headline profit and loss monitoring…. Multiple risk limit breaches and other warnings were not treated seriously, and no effective steps were taken to restrain the Traders’. The NAB’s strategy had been one of reduced levels of proprietary trading. This policy was unilaterally reversed by the traders. Day-to-day involvement and supervision of the traders by Mr Dillon was minimal and there was little supervision by other management in the Markets Division, other than a review of reported profits.13
10 Report by PricewaterhouseCoopers, above n 9, 2. For more details of factual background, see Alin Comanescu, An Inquiry into the Nature and Causes of National Australia Bank Foreign Exchange Losses, an essay submitted to Department of Economics, Queen’s University, Kingston Ontario, Canada, in November 2004. 11 Report by PricewaterhouseCoopers, above n 9, 2. 12 Carolyn Cordery, ‘NAB’s “Annus Horribilis”: Fraud and Corporate Governance’ (2007) 17 Australian Accounting Review 62, 63. 13 Report by PricewaterhouseCoopers, above n 9, 3, 23.
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(2) There was a culture of non-adherence to risk management policies (notwithstanding a number of warning signs).14 There were flaws in the design, implementation and execution of risk management. While ‘risk was an acknowledged business concern, there was a tendency to “push the boundary” on risk in pursuit of revenue targets.’15
The PwC report expresses a number of opinions concerning the NAB’s governance and culture. Some of the more important of these, for present purposes, are that:16
(1) The risk management information that was provided to the board was incorrect, incomplete or insufficiently detailed to alert them to limit breaches or other matters relating to the currency options desk’s operations. (2) Had the Principal Board Audit Committee read supporting papers provided to it, probing of management might have revealed the seriousness of some of the control breakdowns. (3) Warnings by the NAB’s Market Risk and Prudential Control section concerning the currency option desk’s limit breaches and other exceptions were not made known to the CEO or the Board. (4) Importantly, so far as the NAB’s culture was concerned, there was ‘an excessive focus on process, documentation and procedure manuals rather than on understanding the substance of the issues, taking responsibility and resolving matters’.17 There was an arrogance in dealing with warning signs and management had a tendency to ‘pass on’, rather than assume, responsibility.18 The NAB had a culture of high risk-taking combined with a bias towards reporting good news (and under-reporting bad).19
The executive summary of the PwC Report concludes with the following paragraph:
Our investigations indicate that the culture fostered the environment that provided the opportunity for the Traders to incur losses, conceal them and
14 See Report by PricewaterhouseCoopers, above n 9, 25, 26 and Comanescu, above n 10, 38-50. 15 Report by PricewaterhouseCoopers, above n 9, 26. 16 Report by PricewaterhouseCoopers, above n 9, 3, 4. 17 Report by PricewaterhouseCoopers, above n 9, 3, 32. 18 Report by PricewaterhouseCoopers, above n 9, 3. 19 Cordery, above n 12, citing M Maiden, ‘Shareholders May Have Say in NAB Board Feud’, retrieved by her on 1 April 2004 from http://www.theage.com.au/ articles/2004/03/21/1079823238445.html.
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escape detection despite ample warning signs. This enabled them to operate unchecked and flout the rules and standards of the National. Ultimately, the Board and the CEO must accept responsibility for the ‘tone at the top’ and the culture that exists in certain parts of the National.20
When the scandal became public, NAB’s then CEO, Frank Cicutto, at first chose not to resign. The Board supported him in this. He resigned only after management failures became public.21
There is one other fact that deserves comment. The four traders were paid according to the level of profits achieved by them, providing a major incentive for them to ignore the limits set on their trading.22 The traders received bonuses ranging from $120,000-$265,000 as a consequence of meeting profit targets in 200323 (some of the traders also received bonuses for 2001 and 2002).24 When interviewed on 18 February 2004 by the Australian Securities and Investments Commission, one of the traders, Ficarra, said, ‘[a]s far as I was concerned a bonus is a bonus. I’m 25 – only just turned 25 a month ago – a bonus of $100,000 is a lot of money to me’.25
C AWB Ltd and the ‘Oil for Food’ Scandal
As a result of Iraq’s invasion of Kuwait in 1990, the United Nations Security Council (‘UNSC’) imposed sanctions upon Iraq that had the effect of precluding member states from trading with it. Because these sanctions ultimately resulted in a shortage of food, the Security Council, in 1995, adopted Resolution 986, establishing the ‘Oil for Food Programme’. This programme enabled Iraq to sell oil under approved contracts. The sale proceeds were paid into a trust account controlled by the United Nations. Iraq could draw upon funds in the trust account for the purchase of food.
By 1999, the Australian Wheat Board sold about 10 per cent of Australia’s annual wheat exports to Iraq.26 The Australian Wheat
20 Report by PricewaterhouseCoopers, above n 9, 4. 21 Comanescu, above n 10, 35, 41; Report by PricewaterhouseCoopers, above n 9, 2. 22 J Stewart, NAB’s media conference, 12 March 2004, downloaded by Cordery, above n 12, on 6 April 2004 from http://www.nabgroup.com.au. 23 Wall Street Journal (Eastern edition), 26 January 2005. 24 Report by PricewaterhouseCoopers, above n 9, 2. 25 Australian Broadcasting Corporation, ‘Former NAB Traders Jailed’, The 7.30 Report, 4 July 2006. 26 See generally, John Agius SC, ‘The Cole Inquiry into Certain Australian Companies and the UN Oil for Food Program: Lessons for Government’ (2007) 57 Australian Institute of Administrative Law Forum 1; Linda Botterill, ‘Doing it for the Growers in Iraq?: The AWB, Oil-for-Food and the Cole Inquiry’ (2007) 66 Australian Journal of Public Administration 4.
128 JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED?
Board was privatised in 1999 and it became a company, listed on the ASX, known as AWB Ltd (‘AWB’). Although privatised, AWB retained the statutory monopoly that it had previously held by the Australian Wheat Board.
AWB entered into an arrangement with the Iraqi Grain Board (‘IGB’). Under this arrangement, AWB agreed that, from July 1999, IGB should be paid a fee of US $12 per tonne for ‘inland transportation to all governorates Iraq’. The fee was payable through a Jordanian company, Alia for General Transportation and Trade (‘Alia’). Alia was 49 per cent owned by the Iraqi Government.
Those parties making the arrangements on behalf of AWB knew that the fee was a means of extracting money from the UNSC trust account and that the funds were to be paid to another Iraqi entity, the Iraqi State Company for Water Transport. They also knew that Alia was not receiving the money as transportation fees for services provided by it and that the money was, in effect, a bribe.
In April and May 2000, IGB demanded that AWB pay an additional ten per cent ‘after sales service fee’. This had the effect of raising the transport fee to US $44.50 per tonne. AWB executives were aware that this charge, too, had nothing to do with the provision of transport services and was in effect, a bribe.
John Agius SC, counsel assisting the subsequent Cole Inquiry into these events,27 writes that:
Between November 1999 and March 2003 AWB paid Alia USD$224,128,189.98. That sum comprised USD$146,101,906.59 in transportation fees and USD$78,026,283.39 in after sales service fees which was paid in breach of UN sanctions. Alia deducted a commission of 0.25% and the balance was transferred to Iraqi entities. Documents uncovered after the fall of Iraq indicate that approximately two-thirds was paid to the Ministry of Finance and one-third split between “land” (presumably being for land transportation), 4% to “ports” and 1% to water. The two-thirds which went to the Ministry of Finance was otherwise not accounted for.28
A UN Inquiry conducted by Paul Volcker, the former US Federal Reserve Chairman, in 2004 revealed that money paid by AWB constituted 14 per
27 Australian Government Attorney-General’s Department, Report of the Inquiry into Certain Australian Companies in relation to the UN Oil-For-Food Programme (2006) (inquiry conducted by Terence Cole QC). 28 Agius, above n 26, 5.
129 (2010) 12 UNDALR cent of the illicit funds channelled to the Iraqi regime.29 Mr Volcker identified almost 2400 companies from more than 60 countries that had paid $1.8 billion in ‘kickbacks’ to the regime.30 However, AWB’s contribution was the largest, by far, to this total.31
AWB deliberately misled the United Nations and the Australian Department of Foreign Affairs and Trade concerning the true nature of the arrangements entered into by it. Knowledge of the true arrangements was restricted to a small group in AWB’s International Sales and Marketing Division. Other officers of that company, and its Board, were seemingly unaware of what had taken place. When questions began to be asked, AWB consistently denied that it had acted inappropriately.32
Once suspicions had been aroused, AWB conducted internal enquiries and engaged Arthur Andersen to investigate activities of employees working in its International Sales and Marketing Division. In June 2003, it established ‘Project Rose’, a comprehensive investigation into what had occurred, involving external lawyers.
The results of the ‘Project Rose’ investigation were withheld from the Volcker Inquiry. AWB also resisted production of relevant documents to the Cole enquiry on the basis of legal professional privilege. Other documents were produced late, including some that were highly relevant. In his report, Commissioner Cole said that ‘AWB presented a facade of cooperation with the enquiry’ but that, in truth, it had not cooperated at all.33
Commissioner Cole also described the consequences of AWB’s actions as ‘immense’. They included an annual loss of over $385 million worth of trade with Iraq. He said that AWB had ‘cast a shadow over Australia’s reputation in international trade’.34
On 23 February 2006, AWB held an annual general meeting. Six of the directors who had been on the board at the time of these events put themselves up for re-election by the shareholders. All were re-elected.35
29 Paul Volcker, Report of the Independent Inquiry Committee into the United Nations Oil-for-Food Programme: Manipulation of the Oil-for-Food Programme by the Iraqi Regime (2005), quoted by A McConnell, A Gauja and L Botterill, ‘Policy Fiascos, Blame Management and AWB Limited: The Howard Government’s Escape from the Iraq Wheat Scandal’ (2008) 43 Australian Journal of Political Science 599. 30 Then Australian Prime Minister, John Howard, writing in the Asian Wall Street Journal, 25 April 2006. 31 Botterill, above n 26, 4. 32 Botterill, above n 26, 8, 9. 33 Volcker, above n 29, 235, quoted by Botterill, above n 26, 11. 34 Quoted by the Economist, 12 February 2006, ‘Australians Who Bribe’. 35 Derek Parker, ‘Lessons learned?’Management Today October 2007, 28.
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III Why Do Things of This Kind Happen?
The answer to this question requires consideration of a number of contributing factors.
A Separate Personality and Limited Liability
Corporations have long been given separate personality by the law. The principle was well-established by the time that Lord Macnaghten wrote his well known dictum in Salomon v Salomon & Co Ltd:36
The company is at law a different person altogether from the subscribers ... and, though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act.
Section 124(1) of the Corporations Act 2001 (Cth) now provides that, once registered, a company has ‘the legal capacity and powers of an individual’. Section 516 provides for the limited liability of shareholders, who are personally liable for the debts of the company only to the extent of their investment in the company.
Notwithstanding their status as ‘persons’, most companies are not influenced by emotions such as compassion or guilt to anything like the same degree as their flesh and blood cousins (or most of them). When company managers make decisions, they do so upon a corporate basis, with diminished personal responsibility. Company profit is their principal focus.
The film,The Corporation,37 suggests that corporations are legally created psychopaths, diagnosable as such by applying standard clinical diagnostic criteria for that condition. These include a callous lack of concern for the feelings of others, an incapacity to maintain enduring relationships and an incapacity to experience guilt. The makers of the film argue that this corporate psychopath is a product of the law because it provides for separate corporate personality and limited liability and requires directors to give priority to the interests of the company’s shareholders above all other interests, including the public good.38
36 [1897] AC 22, 51. 37 Mark Achbar, Jennifer Abbott (directors) and Joel Bakan (writer), The Corporation (Big Picture Media Corporation, 2003), referred to by Spender, above n 7, 288. 38 Achbar, Abott and Bakan, above n 37; see also Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power(2004); Spender, above n 7, 288.
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Peta Spender, writing in the Griffith Law Review, suggests that:
[C]orporate law is dispassionate because its doctrine is built on articles of faith and utilitarian assumptions about our economic happiness. Consequential arguments reinforce this by focusing upon the dire repercussions which will flow from even minor tinkering with this legal architecture. Law and economics also imbue corporate law with a narrow conception of human nature which not only concentrates upon self-interest but lacks emotional depth. What follows from the dispassion is policy stagnation.39
She puts the principal arguments for and against the notions of limited liability and separate personality as follows:
Structures such as limited liability and separate entity are morally risky, and have always given rise to debate about moral hazard. For example, from the early days of its development, critics opposed limited liability on moral grounds. Because it allowed investors to escape unscathed from their companies’ failures, the critics believed that it would undermine personal moral responsibility … For example, an article published in the Law Times in 1858 argues that the community would provoke dishonesty ‘by exempting men from liability to pay their debts, perform their contracts and make reparation for their wrongs’. It will ‘taint the moral character of those who adopt it.
However, limited liability has a strong utilitarian justification because it puts a ceiling on an investor’s potential losses. This ceiling promotes economic activity by giving the risk-averse investor an incentive to invest. Limited liability also facilitates a separation of ownership and control. It recognises that shareholders are not in a position to monitor the actions of large companies, and therefore should not be subjected to personal liability for something they cannot control.40
She goes on to suggest that the fact that corporate law distances itself from human suffering enables companies such as James Hardie to do the same. She refers to material presented to the Special Commission, which ‘shows that the James Hardie board focused on actuarial studies of potential mass claims which it called “legacy issues”, and effective marketing of unpopular transactions rather than the potentially awkward pain of asbestos victims’.41
The same might be said of AWB. The responsible officers in its Sales and Marketing Division must have known that the bribes paid by AWB would find their way to the leaders of a despotic regime and would undermine the sanctions imposed by the UNSC, but seemingly did not care.
39 Spender, above n 7, 291. 40 Spender, above n 7, 291. 41 She refers to the Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1, Vol 1, 13, [1.25] and Vol 2, Annexure K.
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B Corporate Groups
The position is exacerbated when the owner of a corporation is another corporation. It is further exacerbated if the parent corporation is one of a large group of corporations. As Professor Tom Hadden wrote, some 19 years ago:
Businessmen, and accountants and investors all think about corporate groups rather than individual companies as the main focus of their activities. Only lawyers and legislators … cling to the tradition that individual companies are the only proper focus of attention and that corporate groups are no more than simple or complex combinations of individual companies.42
Nothing much has changed since then. The following comments made by Professor Hadden also remain substantially true:
The traditional rules on the duties of the directors and officers of individual companies make little sense within corporate groups. There are no clear rules on the liability of the group for the obligations of its constituent companies. And there is virtually no legal control at all on the complexity of the group structures which may be established with a view to concealing the true state of affairs within a complex group. The only major recognition of the existence of the group has been the requirement for the consolidation of group accounts, though … the established rules have not proved particularly effective. All this makes it too easy for complex corporate groups to be used to confuse or defraud the business or investment communities. The fact that most of the spectacular corporate failures and frauds in recent years both in Australia and elsewhere have been carried out within or by means of complex corporate groups is in itself an indication of the need for more effective regulation.43
Groups are a well-established form of large corporate enterprise in Australia. A study of the top 500 companies in 1997 showed that 89 per cent of them had at least one controlled entity.44 The median number of controlled entities was 11 (90 per cent of these were wholly owned by other companies in the group).45
This brings with it another set of problems. In Re Southard and Co Ltd46 Templeman LJ said:
A parent company may spawn a number of subsidiary companies … If one of the subsidiary companies … turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and other subsidiary companies may prosper to the joy of shareholders without any liability for the debts of the insolvent company.
42 Tom Hadden, ‘The Regulation of Corporate Groups in Australia’ (1992) 15 University of New South Wales Law Journal 61, 61. 43 Hadden, above n 42, 62. 44 Ian Ramsay and Geof Stapledon, ‘Corporate Groups in Australia’ (2001) 29 Australian Business Law Review 7, quoted by Spender, above n 7, 285. 45 Ramsay and Stapledon, above n 44, 285. 46 (1979) 1 WLR 1198, 1208.
133 (2010) 12 UNDALR In her article, Spender applies this reasoning to what was done by James Hardie and, changing the metaphor, concludes that ‘members of a corporate group may cast out elderly, troublesome and costly relatives after passing the family debt on to them’.47 She points out that, consistently with this, Commissioner Jackson found that the James Hardie reorganisation was in accordance with the letter of the law and that companies within the Group would not be liable for the torts of any other company, with the consequence that asbestos victims’ claims for compensation were confined to a limited fund.48 It was this that led the Commissioner to conclude that there were ‘significant deficiencies in Australian corporate law’ and he added that the circumstances ‘raised in a pointed way the question whether existing laws concerning the operation of limited liability … within corporate groups adequately reflect contemporary public expectations and standards’.49
The issue also raises its head in other contexts.
Directors might, in some cases, be inclined to pay more regard to the interests of the group than to those of the individual company. That can lead to decisions being made by the company that are not in its interests, for example, guaranteeing the debts of other companies in the group, which are of questionable solvency, or lending money to those companies.50
Also, persons dealing with one company in a group may be misled by the strength of the group into making no enquiries concerning the financial viability of the particular company, causing them to beleft unpaid, on the insolvency of that company, in circumstances in which they would never have done business with the company were it not for the strength of the group.
While the law does, in some circumstances, allow the corporate veil to
47 Spender, above n 7, 286. 48 Spender, above n 7, 285, suggests that the rules about liability in corporate groups interfere with the objectives of tort law because, although the tort victims become creditors to the extent of any damages that are awarded, the principle of limited liability denies them access to members’ assets. She points out that this can result in inadequate compensation, interfere with the tort law’s objective of compensation and undermine corrective justice and deterrence. 49 New South Wales, Special Commission of Inquiry into the Medical Research and Compensation Foundation, above n 1, Vol 1, [30.66]. 50 Although there are constraints on their doing so, particularly in the context of possible insolvency: see Reid Murray Holdings Ltd (in liq) v David Murray Holdings Pty Ltd (1972) 5 SASR 386, 402; Charterbridge Corp Ltd v Lloyd’s Bank Ltd [1970] Ch 62; ANZ Executors and Trustees Co Ltd v Qintex Australia Ltd (recs & mgrs appointed) [1991] 2 Qd R 360.
134 JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED? be lifted so as to enable the operations of a subsidiary to be regarded as those of its parent, such cases remain comparatively isolated.51
C Corporate Culture
Corporate culture is critical to corporate behaviour. One writer, T Tierney, defines corporate culture as ‘what determines how people behave when they are not being watched’.52 Another, E Schein, defines it as the ‘sum total of all the shared, taken-for-granted assumptions that a group has learned throughout its history’.53
Employees within a corporation tend to act according to its ethical culture.54 That culture, in turn, takes its shape from those who run the corporation and from how the corporation is run. This is so regardless of what might appear in written ethical guidelines. If there is too strong a focus on profit, and an inadequate focus on ethics, unethical behaviour by employees becomes more likely. M Young writes that:
We have learned the same thing again and again; financial fraud does not start with dishonesty, your boss doesn’t come to you and say, ‘Let’s do some financial fraud’. Fraud occurs because the culture has become infected. It spreads like an unstoppable virus.55
This happens even if the company’s employees behave ethically in other contexts.56
51 See the comments of Rogers CJ in Qintex Australia Finance Ltd v Schroders Australia Ltd [1990] ACSR 267, 268-269 and in Briggs v James Hardie & Co Pty Ltd (1989) 7 ACLC 841 and see Hadden, above n 42. In James Hardie & Co Pty Ltd v Putt (1998) 43 NSWLR 554 the NSW Court of Appeal held that, absent evidence that a subsidiary company was a mere facade, exercise of control and influence by a parent did not, of itself, justify lifting the corporate veil so as to create a duty of care owed by the parent to an employee of the subsidiary. Cf CSR Ltd v Wren (1997) 44 NSWLR 463 and see generally, ASIC v Macdonald (No 11), (2009) 256 ALR 199. 52 T Tierney quoted in The Economist 364, Issue 8283, 61, in turn quoted by H and J Rockness, ‘Legislated Ethics: From Enron to Sarbanes-Oxley: The Impact on Corporate America’ (2005) 57 Journal of Business Ethics 31, 48. 53 E Schein The Corporate Culture Survival Guide (1999) quoted by H and J Rockness, above n 52, 48. 54 Lynne Dallas, ‘A Preliminary Inquiry into the Responsibility of Corporations and their Directors and Officers for Corporate Climate: the Psychology of Enron’s Demise’ (2003) 35 Rutger’s Law Journal 1, 10; Christine Parker, The Open Corporation (2002) 32; Matthew Harvey and Suzanne Le Mire, ‘Playing for Keeps? Tobacco litigation, Document Retention, Corporate Culture and Legal Ethics’ (2008) 34 Monash Law Review 163, 175; Suzanne Le Mire, ‘Document Destruction and Corporate Culture: A Victorian Initiative’ (2006) Australian Journal of Corporate Law 304, 312. 55 M Young, quoted by P Sweeney, ‘What Starts Small Can Snowball’ (2003) Financial Executive, in turn quoted by H and J Rockness, above n 52, 47. 56 Parker, above n 54, 33; Harvey and Le Mire, above n 54, 175: Le Mire, above n 54, 312.
135 (2010) 12 UNDALR Professors Howard and Joanne Rockness57 refer to a number of studies in this regard. They say:58
The tone at the top has been cited as the primary driver of corporate ethical conduct by many professional sources (e.g., AICPA: 2002;59 COSO, 1992;60 Treadway Commission, 198761). Ethicists have long argued that tone drives the corporate culture (Buchholz and Rosenthal, 1998,62 p.177). Sweeney (2003)63 argued that the tone at the top sets the corporate culture and in many cases was a root cause of the unethical conduct and fraudulent activities. He cites two common characteristics: overly aggressive financial performance targets and a can-do culture that did not tolerate failure...
In this culture, what often began as questionable accounting adjustments grew into massive fraud in an attempt to fix each quarter’s numbers to close the variance between income targets and actual results. The classic slippery slope of unethical behaviour prevailed as otherwise honest people came to believe they were acting in the best interest of the company and consented to participating in unethical and fraudulent behaviour. Personal gain, ego and survival were perhaps all motivating factors for the individuals involved. The impact of senior management on the corporate culture and resulting frauds are illustrated by taking a closer look at three of the biggest scandals: Enron, WorldCom and HealthSouth.
For present purposes, it is unnecessary to look closer at the three well- known scandals mentioned in this extract. The AWB and the NAB scandals are sufficient to illustrate the point.
AWB had a set of ethical guidelines that, unsurprisingly, prohibited the payment of bribes. This was ignored by senior employees in its International Sales and Marketing Division. The company’s culture was one of maximizing returns to growers.64 One of AWB’s former employees, Mark Rowland, provided a statement to the Cole Inquiry that included the following:
There was certainly a culture of pushing the business of AWB as far as possible for the highest return. My perception was that on occasion, this might mean that the company moved into what some might describe as “grey areas”, where
57 H and J Rockness, above n 52. 58 H and J Rockness, above n 52. 59 AICPA: 2002, ‘Consideration of Fraud in a Financial Statement Audit’, Statements on Auditing Standards 99, AICPA, Professional Standards, Vol 1, AU sec.316. 60 COSO (Committee of Sponsoring Organisations of the Treadway Commission): 1992, ‘Internal Control and Integrated Framework’ (Institute of Internal Auditors, New York); Treadway Commission. 61 Treadway Commission (National Commission on Fraudulent Financial Reporting): Report of the National Committee on Fraudulent Financial Reporting (Committee of Sponsoring Organizations of the Treadway Commission, New York). 62 R Buchholz and S Rosenthal, Business Ethics: The Pragmatic Path Beyond Principles to Process (1998). 63 Sweeney, above n 55. 64 Botterill, above n 26, 11.
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the legality of the position adopted by AWB might be open to doubt. If the commercial imperative justified the position adopted, in my experience, the company adopted that position in order to vigorously protect its customers and markets from overseas competitors. All of AWB management, as far as I could discern, were driven to ensure that the company maximised its trading capacity on behalf of Australian wheat growers.65
NAB had corporate governance codes that ‘seemed exemplary’.66 Largely because of too great a focus on profit (although there were other contributing factors), these failed to prevent unauthorised secret dealings resulting in the announcement of $360 million in foreign exchange losses, less than four months after reporting a profitable year.67
A company’s board can play a large part (good or bad) in setting a corporate culture. H and J Rockness make this point in their article on corporate ethics.68 After giving a number of illustrations, they go on to suggest that the board must be responsible for ethics and must ensure that there is ‘a culture that supports, nurtures and attracts individuals of high personal integrity’.69 They say that this can be done by noticing, and rewarding, ethical behaviour; by encouraging the departure of those who violate ethical principles, no matter how valuable their other contributions may be; and by ensuring that there is an appropriate control environment involving oversight by senior management.
AWB provides a good (or bad) example of what can go wrong when there is a board that lacks an incentive to question management policies and oversight. AWB’s board remained unaware of what had happened for far too long and, even when its suspicions were eventually aroused, it took far too long to discover the truth.70 Much the same was true of NAB, where the emphasis on profit led to a failure to look closely at risk and to ensure that there were adequate risk control measures in place.
James Hardie provides an illustration of a different kind. The Group claimed that it had been restricted in its ability to put aside enough money for outstanding asbestosis liabilities because of the requirement, imposed by the Corporations Law, that directors should act in the interests of shareholders.71 However, the interests of shareholders presented no justification for defeating the lawful claims of asbestosis victims against the company.
65 Exhibit 0009 AWB.5035.0337, quoted by Botterill, above n 26, 11. 66 Cordery, above n 12, 62. 67 Cordery, above n 12, 63. 68 H and J Rockness, above n 52. 69 H and J Rockness, above n 52, 49-50. 70 See Botterill, above, n 27, 10. 71 See Dr Rodger Spiller, ‘Investing in Ethics - Future Patterns and Pathways’ (2006) New Zealand Management 46.
137 (2010) 12 UNDALR Directors are entitled to assume that shareholders expect them to act ethically. The interests of shareholders should not be protected by the unethical acts of the company’s board of directors. Nor should they be protected by acts that are significantly damaging to the wider community, even if they are within the strict letter of the law. Acts of that kind can have a very significant impact in social cost. Mark Schwartz, a lecturer of business ethics in The Wharton School, University of Pennsylvania, writes that:
One estimate is that the total social costs of US corporations and other businesses that must be borne by employees, customers, communities and society (including such categories as worker accidents, consumer injuries, pollution, and crime) comes to approximately 2 1/2 trillion dollars per year (Estes, R: 1996, Tyranny of the Bottom Line (Berrett-Koehler Publishers, San Francisco, CA, p 178).72
Ethical behaviour involves more than putting the interests of shareholders first, subject to the requirements of the law. It requires that consideration be given to interests, norms and values regarded as important by the general community. Mollie Painter-Morland, in her book on business ethics, writes that:
Both legality and morality are concerned with establishing criteria for acceptable behaviour. Both make these judgements on the basis of existing social norms and values. These norms and values are expressions of those things that the members of a particular community consider important enough to protect and nurture. The protection of our lives and property, for instance, is guaranteed by law. Naturally these primary security needs are exceptionally important, but there are things that speak to the very core of our self-understanding as human beings that we don’t necessarily want to secure through legislation or regulation. Consider, for instance, the implications of legally enforcing things like fidelity, trust, responsibility and care. The world would be a sad place indeed if we felt compelled to adopt a law to ensure that friends cared for one another and trusted each other. However, it would be an even sadder place if we didn’t think these things important at all. Ethics is, in a sense, the practice of such things in everyday life.73
There is no reason why the practice of such things should be less important, in the case of directors giving effect to corporate personality, than they are to any other persons, even if we accept Milton Friedman’s claim that ‘the business of business is business’.74
D Directors and Conflict of Interest
Distinctions are often drawn between ‘inside’ and ‘outside’ directors. The former category includes current or former executives of the company or persons related to current executives. All other directors
72 M Schwartz, ‘The Nature of the Relationship between Corporate Codes of Ethics and Behaviour’ (2001) 32 Journal of Business Ethics 247, 247. 73 Mollie Painter-Morland, ‘Business Ethics as Practice’ (2008) 3. 74 Painter-Morland, above n 73, 144.
138 JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED? fall into the latter category.75 Outside directors, in turn, might be ‘grey’ directors or ‘independent’ directors. ‘Grey’ directors are those who have connections with the company apart from their role as directors. They might, for example, be existing or former consultants to the company or executives of businesses dealing with the company.76
Studies have revealed that independent directors generally protect the interests of shareholders better than ‘inside’ or ‘grey’ directors. Some of these studies are summarised by Andrew Felo as follows:77
Extant empirical evidence gathered in a variety of situations is generally consistent with [the] idea [that independent directors protect the interests of shareholders more effectively than other directors]. For example, Rosenstein and Wyatt78 … find evidence of positive abnormal returns surrounding the appointment of an independent director to a firm’s board. Also, Mehran79 … finds evidence that the proportion of equity-based management compensation is significantly positively related to the proportion of independent directors on a firm’s board. Cotter et al80 … find that takeover targets having boards with a majority of independent directors earn statistically significantly higher returns during takeover periods than do other firms. Brickley et al81 … find that the market reaction to the adoption of poison pills … is significantly positively related to the proportion of independent directors on a firm’s board. Finally, Weisbach82 … finds that firm value significantly increases when boards dominated by independent directors replace CEO’s.
Extant evidence also supports the notion that inside and grey directors may be more closely aligned with a firm’s managers than with a firm’s shareholders. For example, Lee et al83 … find evidence of significantly lower abnormal returns surrounding management buyouts when boards are dominated by inside directors. Brickley et al84 … find that market reaction to the adoption of poison pills is significantly negative for boards dominated by inside and grey directors.
75 See Andrew J Felo, ‘Ethics Programs, Board Involvement, and Potential Conflicts of Interest in Corporate Governance’ (2001) 32 Journal of Business Ethics 205, 208. 76 Felo, above n 75. 77 Felo, above n 75, 208-209. 78 S Rosenstein and J Wyatt, ‘Outside Directors, Board Independence, and Shareholder Wealth’ (1990) 26 Journal of Financial Economics 175, 191. 79 H Mehran, ‘Executive Compensation Structure, Ownership and Firm Performance’ (1995) 38 Journal of Financial Economics 163, 184. 80 J Cotter, A Shivdasani and M Zenner, ‘Do Independent Directors Enhance Target Shareholder Wealth During Tender Offers?’ (1997) 43 Journal of the Financial Economics 195, 218. 81 J Brickley, J Coles and R Terry, ‘Outside Directors and the Adoption of Poison Pills’ (1994) 35 Journal of Financial Economics 371, 390. 82 M Weisbach, ‘Outside Directors and CEO Turnover’ (1988) 20 Journal of Financial Economics 431, 460. 83 C Lee, S Rosenstein, N Rangan and W Davidson III, ‘Board Composition and Shareholder Wealth: The Case of Management Buyouts’ (1992) (Spring) Financial Management 58, 72. 84 Brickley, Coles and Terry, above n 81.
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Additionally, firms filing for bankruptcy have significantly higher proportions of inside and grey directors five years prior to the filing than do similar firms not filing for bankruptcy (Daily and Dalton85…).
Felo points to another problem.86 This is that directors might be reluctant to discipline ineffective managers if the directors have an affiliation with the company or its management team other than asa director. This is particularly true of inside directors, although it is also likely to be true in the case of grey directors.
Independent directors will usually be less influenced by the bottom line than those with a more personal stake in the company. The kind of problem that might follow from too great an emphasis on profit is illustrated by the AWB scandal. The majority of AWB’s board comprised people with a background of wheat farming. Not surprisingly, this led to a culture of maximising returns to growers of wheat. Stephen Bartos, formerly Professor of Governance at the University of Canberra, suggests that the board ‘saw themselves as working on behalf of Australian wheat exporters’ and that ‘they had no incentive to question their managers, so long as wheat kept being sold’.87
The attitude of AWB’s directors was reflected in that of wheat growers. Botterill88 points out that, when they heard of the scandal, growers, rather than being horrified by the activities of AWB on their behalf, rationalised what had been done by saying that this was the way that business was done in the Middle East and by emphasising the need to prevent loss of the market to American competitors. Her comments in this respect are graphically supported by the fact (mentioned above) that, when put up for re-election on 23 February 2006, six of the directors who had been on the board during the period in which bribes of more than $300 million had been paid were re-elected.
E The Approach to Remuneration
There are two pertinent aspects of the issue of remuneration, for present purposes. The first relates to the size of payments authorised by boards. The second relates to incentive payments. The two aspects often go hand in hand.
85 C Daily and D Dalton, ‘Bankruptcy and Corporate Governance: The Impact of Board Composition and Structure’ (1994) 37 Academy of Management Journal 1603, 1617. 86 Felo, above n 75, 205. 87 Stephen Bartos, ‘Against the Grain: The AWB Scandal and Why It Happened’, quoted by Derek Parker, ‘Lessons learned?’Management Today October 2007, 28-29. 88 Botterill, above n 26, 11.
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In its recent report, released on 4 January 2010 (resulting from its 2009 Inquiry into executive remuneration in Australia), the Productivity Commission found that the remuneration of chief executives of the 50- 100 largest Australian listed companies had increased by 300 percent between 1993 and 2007. Since 2007, this trend has been reversed to some degree, with pay returning to 2004-05 levels. The remuneration of chief executives of the top 20 listed companies averaged $7.2 million in 2008-09, 110 times the average wage. The Productivity Commission found that almost all recent growth in remuneration had resulted from the approach of linking remuneration with performance. It remarked that, in principle, boards will be prepared to pay executives a risk premium if they consider that the associated incentives (at least) improve company performance commensurately over time. It said that, in this sense, ‘incentive pay can be a positive sum game, with rewards accruing to both the executive and shareholders’.89
However, the Productivity Commission also said:
[W]hile greater use of incentive pay has almost certainly led to higher reported pay over time, in practice, it might not have translated to improved company performance. Compliant boards, or the difficulties posed for them by very complex incentive pay arrangements, could allow executives to mould performance measures and hurdles in their favour, so that ‘at risk’ pay becomes a virtual certainty, perhaps even rewarding and encouraging poor performance.90
The Productivity Commission also discussed the advantages and disadvantages of short-term and long-term incentives. It said, in this respect:
The complexity of some incentive pay arrangements in more recent times ... could have allowed unanticipated upside (especially during the share market boom prior to 2007-08), yet weakened or distorted the incentive effects for executives.
Short-term incentives linked to inappropriate performance metrics in the finance industry in some instances encouraged excessive risk-taking, although they appear to have been far less pervasive in Australia than overseas. Such practices are the focus of the Australian Prudential Regulation Authority’s new remuneration guidelines.
The Commission understands that executives view some complicated long-term incentives linked to share market performance as akin to a lottery, such that they have little (positive or negative) incentive effect, yet could end up delivering large payments to the executive at large cost to the company.91
89 Australian Government Productivity Commission, Executive Remuneration in Australia, Report No 49 (2009), xxi. 90 Australian Government Productivity Commission Report No 49, above n 89, xxii. 91 Australian Government Productivity Commission Report No 49, above n 89, xxv.
141 (2010) 12 UNDALR People have become accustomed to the massive pay rates awarded to senior executives. But, by any rational measure, it is impossible to justify a salary of $7.2 million per annum. The only persuasive justification is that this is the ‘going rate’ for chief executives in other similar companies. However, that establishes no more than that the malaise is widespread. When pay rates are linked to short term profitability, already money oriented executives are given an incentive to maximize reported profits. As the NAB scandal reveals, the problem may not be limited to senior executives.
F Legal Amorality
Amorality of legal advisers also plays its part. The practice of law requires, to a degree, the suspension of ordinary moral values. Lawyers are required to put the interests of their clients ahead of those of other people, subject to the overriding duties owed by them to the administration of justice and to the courts. Their training encourages them to look at what the letter of the law permits or forbids, rather than what morality requires. It is not their role to make moral judgements on behalf of their clients. It is their role to advise their clients concerning the law.
A respected US commentator, Richard Wasserstrom says that:
Where the attorney/client relationship exists, it is often appropriate and many times even obligatory for the attorney to do things that, all other things being equal, an ordinary person need not, and should not do. What is characteristic of this role of a lawyer is the lawyer’s required indifference to a wide variety of ends and consequences that in other contexts would be of undeniable moral significance. Once a lawyer represents a client, the lawyer has a duty to make his or her expertise fully available in the realisation of the end sought by the client, irrespective, for the most part, of the moral worth to which the end will be put or the character of the client who seeks to utilise it. Provided that the end sought is not illegal, the lawyer is, in essence, an amoral technician whose peculiar skills and knowledge in respect of the law are available to those with whom the relationship of client is established.92
Other commentators have identified this feature of legal practice and its potentially serious consequences. One of them, Professor Gerald Postema, writing in the New York University Law Review, suggests that:
92 Richard Wasserstrom, ‘Lawyers as Professionals: Some Moral Issues’, in Luban (ed) The Good Lawyer: The Lawyer’s Role and Lawyers’ Ethics (1984); also published in Richard Wasserstrom, ‘Lawyers as Professionals: Some Moral Issues’ (1975) 5 Human Rights 1.
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the artificial reason of professional morality, which rests on claims of specialised knowledge and specialised analytical technique, and which is removed from the rich resources of moral sentiment and shared moral experience in the community, tempts the professional to distort even the most serious of moral questions.93
G Auditors
Auditors have sometimes played a significant role by failing to identify indicators of impending corporate collapses, in some cases because they lacked the incentive to do so.
In their article on ‘legislated ethics’,94 Professors H and J Rockness quote from a speech made by A Levitt of the US Securities and Exchange Commission (‘SEC’) on 10 May 2000. They record him as saying, ‘too many auditors are being judged not just by how well they manage an audit, but by how well they cross-market their firm’s non- audit services.’ 95 H and J Rockness go on to say that all of the ‘Big Five’ CPA firms were criticised during the 1990s ‘for inadequate audit procedures, a strong focus on increasing the breadth and volume of consulting services, providing internal audit services to external audit clients, and utilising the accounting rules to the advantage of audit clients rather than focusing on underlying economic substance’.96
Criticisms of this kind led the SEC to push for new regulations on auditor independence, imposing limits on services that might be provided to audit clients so as to avoid conflicts of interest. This push was opposed by the (then) ‘Big Five’, by the American Institute of Certified Public Accountants and also by many corporations.97 Ultimately, there was a legislative response by way of the enactment of the Sarbanes-Oxley Act 2002 (discussed briefly below).
H and J Rockness mention that, after the coming into effect of the 2000 SEC regulations, but before the enactment of the Sarbanes-Oxley Act, one of the big accounting firms, Arthur Andersen, continued providing significant consulting services to the Enron Energy Group in addition to external audit services. They say:
Total Enron-based revenue was $55 million in 2000 with $27 million from consulting services. As Enron collapsed, so did Andersen. Within six months of the Enron bankruptcy filing, Andersen was found guilty of obstruction of justice but they also admitted failures in internal processes to ensure quality audits
93 Gerald Postema, ‘Moral Responsibility in Professional Ethics’ (1985) 55 New York University Law Review 63, 65. 94 H and J Rockness, above n 52. 95 H and J Rockness, above n 52, 40. 96 H and J Rockness, above n 52, 40-42. 97 H and J Rockness, above n 52, 42.
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and professional integrity …. The tone at the top and culture in Andersen had parallels to the previously discussed corporate cultures. Anderson had placed great emphasis on growth with evidence suggesting that client satisfaction and growth may have been more important than ethical financial reporting (J A Byrne: 2002, ‘Fall From Grace’, Business Week, August 12, 51-56).
The remaining Big Four continue to have ethical and financial reporting problems. A critical question is, can the US and global economic systems afford to lose another major accounting firm? If not, can the Sarbanes-Oxley Act promote the ethical behavior necessary for survival? 98
One factor that is pertinent to the last of the questions posed by H and J Rockness is that auditors will always have a basic conflict of interest arising out of the fact that they are paid for what they do, with the consequence that the bodies audited are their clients, often important clients. The following extract appeared in the Economist on 18 November 2004:
The Sarbanes-Oxley Act [was] passed in the wake of the Enron and other scandals. … Yet more needs to be done. Accountancy firms remain riddled with conflicts of interests. The most basic is that they are responsible for auditing managements that, ultimately, pay them to do so.99
Other commentators have expressed similar opinions. Carolyn Windsor and Bent Warming-Rasmussen say that:
This regulatory arrangement had an inherent critical flaw identified by … [RK Mautz and HA Sharaf, ‘The Philosophy of Auditing’, New York: American Accounting Association (1961)]. They questioned the ability of professional auditors to maintain an independent mind to ‘present fairly’ in the judicial sense… [SA Reiter and PF Williams, ‘The Philosophy and Rhetoric of Auditor Independence Concepts’, (2004) 14 Business Ethics Quarterly 355] when they are economically dependent on the client management. This regulatory flaw predisposes conflicts of interests because auditors have to negotiate compensation and employment conditions with the regulated, the auditee company.100
They go on to suggest that ‘regulatory capitalism was instrumental in the reinvention of the audit as a commodity driven by economic considerations of the “client”, the corporate auditee and its management…’.101 They criticise the regulation of the profession, saying that:
[It] has seen massive corporate scandals where auditors gave clean opinions to companies that ended in bankruptcies and brought on the catastrophic collapse
98 H and J Rockness, above n 52, 42. 99 Quoted by Carolyn Windsor and Bent Warming-Rasmussen, ‘The Rise of Regulatory Capitalism and the Decline of Auditor Independence: A Critical and Experimental Examination of Auditors’ Conflicts of Interest’ (2009) 20 Critical Perspectives on Accounting 267, 268. 100 Ibid. 101 Ibid, 269.
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of the once reputable accounting firm, Arthur Andersen. The community including investors, employees, creditors, bankers, and retirees has suffered significant financial loss, employment and future economic security…. Further, the benefits of competition are illusive, as the competitors in the market for audits has [sic] shrunk in a flurry of mergers over the last three decades and acquisitions that have swallowed several smaller professional audit firms into a transnational oligopoly of the “Big 4”…102
They conclude, pessimistically, that ‘merely prescribing more rules in the professional code of ethics will fail to achieve actual and perceived auditor independence’.103 They add, even more pessimistically, that:
The code assumes the humanly impossible, that all members of the profession have the ethical predisposition to consistently perform the altruistic requirement of pulling the public interest ahead of self-interest…. Kane … [EJ Kane, ‘Continuing dangers of disinformation in corporate accounting reports’, (2004) 13 Review of Financial Economics, 149] … concluded: ‘The strategy of relying on the personal honour, professional ethics and reputational risk aversion of watchdogs to refute dishonest reporting has failed dramatically.’
The reality is that auditors are dependent on corporate clients in a contrived competitive, marketized environment imposed by the state and controlled by regulatory capitalism. In turn regulatory capitalism relies on the accounting profession’s expertise and legitimate power to spread the regime’s neo-liberal policies of deregulation and privatization worldwide through the transnational network of professional services firms. Thus, the transformed profession has become the transformer but at a price, the loss of public confidence and the decline of ethicality necessary for auditor independence. Conflict of interests still abound.104
IV Is there an antidote?
All of this adds up to a potentially poisonous mixture. It is difficult, even impossible, to find a single antidote. However, it is worth examining some of the measures that have been taken, and considering others that might be taken.
A Legislative Responses
Legislative responses provide an answer, but they are not the answer to the problem of corporate misbehaviour. They are able to travel only part way down the road of creation of a culture of ethical compliance. Moreover, overregulation becomes constricting, even paralysing.
102 Ibid. 103 Ibid, 285. 104 Ibid.
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The United States of America provides a good example of the failure of legislation to provide a complete answer. H and J Rockness, summarise some of the corporate scandals in that country, and the legislative responses to them.105
They describe the 1920s as a time of greed, resulting in a number of famous frauds in the period leading up to the crash of 1929. The US Congress responded by enacting the Securities Acts of 1933 and 1934. These established the SEC (US Securities and Exchange Commission), regulated trading in securities, imposed common accounting standards and required publicly traded companies to be audited by Certified Public Accountant (CPA) firms.
However, the problems remained. H and J Rockness record that the 1960s ‘were marked by real estate scandals filled with creative accounting, and the 1970s saw international fraud and bribery resulting from numerous unethical behaviours’.106
The US Congress responded by enacting the Foreign Corrupt Practices Act 1977. This imposed ethical standards on companies having dealings in foreign countries and attempted to curtail fraud and bribery, resulting in increased audit procedures.
Again, problems continued. The 1980s
experienced the failure of real estate driven savings and loans, as well as widespread Wall Street corruption, fraudulent reporting, insider trading and junk-bond schemes … By 1991, the Federal Bureau of Investigation (‘FBI’) had budgeted more than $125 million to pursue cases of financial fraud in the S & L industry (US Congress: Senate, 1992) and the (then) Big Six CPA firms paid $1.6 billion to settle fraudulent reporting charges levied against them by the federal government …107
Another legislative response followed. In 1991 the US Congress enacted the Federal Deposit Insurance Corporation Improvement Act, which addressed fraud in respect of savings and loans. In 1995 the Private Securities Litigation Reform Act limited the liability of CPA firms (as a result of litigation arising out of savings and loan failures) and required auditors to report fraud to the SEC. Also, in 1987 the Treadway Commission prepared a report making a number of recommendations designed to prevent fraud in financial reporting.
105 H and J Rockness, above n 52. 106 H and J Rockness, above n 52, 32. 107 H and J Rockness, above n 53, 32.
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Still, the problems continued. H and J Rockness go on to say:
The 1990s brought an unprecedented era of fraudulent reporting and unethical corporate management behaviour. The dot.com phenomena, a new economy of technology, communications, day-trading, a roaring bull market, and a surge of initial public offerings often creating instant wealth made this period unlike any time in history. The use of incentive-based compensation schemes provided the incentives, and continued development of computer technology and the transfer of records from paper to machine paved the way to countless opportunities for fraud in financial reporting.
A new round of corporate failures began in the late 1990s and early 2000s. The unethical actions of corporate leaders led to bankruptcies and restatements of a magnitude unimagined in prior decades. Since 1997, more than 10% of US public companies have restated their reports resulting in market capitalization losses in excess of $100 billion … In the twelve-month period ending June 30, 2003 alone, 354 companies restated earnings… The sheer size of the failures dwarfed previous scandals.108
There followed the enactment of legislation (the Sarbanes-Oxley Act 2000) described by then US President, George W Bush, as ‘the most far reaching reforms of American business practices since the time of Franklin Delano Roosevelt’.109 He went on to say, optimistically, that the era of low standards and false profits was over.
It is beyond the scope of this article to summarise the extensive provisions of the Sarbanes-Oxley Act.110 However, it substantially increased the responsibilities (and independence) of corporate audit committees, introduced a number of measures designed to ensure auditor independence and efficiency and substantially raised penalties for various forms of corporate misconduct.
In addition, in November 2003 the Federal Sentencing Commission promulgated guidelines (to which I will return below) that were designed to ensure that sanctions were sufficiently severe to deter, prevent and punish corporate criminal offences.
President Bush’s optimism concerning the end of an era of low standards and false profits was misplaced, as recent events have graphically demonstrated. Even before those events, H and J Rockness wrote, in 2005, that:
Almost two years have passed since the signing of the Sarbanes-Oxley Act … and the scandals and restatements continue. We are still witnessing corporate misconduct and failure, as well as unethical actions in hedge funds, the stock exchanges, and mutual funds.111
108 H and J Rockness, above n 52, 35. 109 Quoted by H and J Rockness, above n 52, 51. 110 Its key features are identified by H and J Rockness, above n 52, 45-48. 111 H and J Rockness, above n 52, 42.
147 (2010) 12 UNDALR Experience in Australia has been similar. Scandals involving such persons or entities as Alan Bond, Christopher Skase and the HIH Insurance Group are said by Mike Lotzof, the CEO of the Australasian Compliance Institute, to have resulted in ‘a regulatory avalanche that threatened to drive compliance back into the land populated only by aggressive regulators, defensive lawyers, and reactive corporations’.112 Included in this ‘regulatory avalanche’ are the amendments introduced by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004 (CLERP 9 Act). These encompassed a number of measures (some of which are discussed below) that were designed to ensure a reasonable level of independence by auditors.113 The Act also introduced provisions requiring additional disclosure, particularly concerning remuneration of board members and senior managers.
Legislative interventions of this kind are undoubtedly of some assistance, but most commentators agree that they do not provide a complete answer, or anything approaching it. H and J Rockness say that:
[T]he almost one hundred year history of US legislation attempting to impose transparency, integrity and honesty as underlying values in corporate management and financial reporting has failed to prevent periodic systemic ethical failure. They often have proved effective for a time. However, management and their external auditors have responded to legislated behaviours by finding new ways to obscure results; defraud shareholders, customers, or suppliers; and hide failure. In the latest wave of corporate fraudulent reporting, the SEC history of fines for offending corporations and civil proceedings against senior management evidently were not effective deterrents.114
R Solomon, in his book on ethics,115 suggests that legislative responses will only help prevent behaviours already viewed as inappropriate by those subject to the laws and regulations. They consequently complement an appropriate ethical culture rather than replace the need for one.
Painter-Morland contends, similarly, that:
Despite its widespread implementation, [a] legislative approach does not seem to be working as well as its proponents might have hoped. News of fresh business scandals continues to arrive at our doorsteps almost every morning. Judged on
112 M Lotzof, ‘Compliance in Australia Has Continued to Evolve Over the Last 20 Years’ (2006) 8 Journal of Health Care Compliance 73, 74. 113 These resulted from recommendations made in the October 2001 Ramsay report, ‘Independence of Australian Company Auditors: Review of the Current Australian Requirements and Proposals for Reform’ and ‘The Report of the Royal Commission into the Collapse of the HIH Insurance Group’ (April 2003). 114 H and J Rockness, above n 52, 47. 115 R Solomon, The New World of Business: Ethics and Free Enterprise in the Global Nineties (1994), quoted by H and J Rockness, above n 52, 51.
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the basis of their performance, then, rules and legislation alone appear to be poor substitutes for the kind of practical wisdom that is inscribed in the notion of ethics as practice. In fact, efforts to formulate unambiguous normative guidelines for the conduct of business may paradoxically cause us to neglect those very aspects of human life that both legality and morality attempt to protect.116
She expresses a similar opinion concerning the US Federal Sentencing Guidelines (‘FSG’):
According to the FSG, if a business organization charged with corporate misconduct has [prescribed] elements [of structured ethics and compliance programs] in place and cooperates fully with investigating authorities it might be given a reduced fine, or even avoid prosecution altogether. Many organizations did the math and realized that investing in an ethics program would probably cost them less than they stand to lose in the event of a lawsuit. The problem, of course, is that when ethics programs are motivated by this kind of logic, they can end up being no more than relatively cheap insurance policies against costly lawsuits.117
B Calls for Ethical Governance and the Development of Codes of Conduct
There are many ‘motherhood’ statements calling for ethical governance of large companies.
One of the Organisation for Economic Co-operation and Development’s (‘OECD’) revised Principles of Corporate Governance is that corporate boards should apply high ethical standards.
ASX Listing Rule 4.10.3 has, as one of the items in its list of corporate governance matters, the establishment and maintenance of appropriate ethical standards.
In 2003, the ASX Corporate Governance Council developed a set of ‘Principles of Good Corporate Governance and Best Practice Recommendations’, revised in 2007 under the title ‘Corporate Governance Principles and Recommendations’ (‘ASX Principles’), which recommends the development by corporations of codes of conduct designed, amongst other things, to ‘promote ethical and responsible decision-making’.118 Public companies are required by the ASX Listing Rules to comply with the ASX Principles or to explain their reasons for not doing so. Principle 3 of the ASX Principles is that companies should actively promote ethical and responsible decision- making. Recommendation 3.1 of the ASX Principles is that companies should establish a code of conduct and disclose relevant aspects of it.
116 Painter-Morland, above n 73, 3. 117 Painter-Morland, above n 73, 8. 118 Recommendation 3.1 and Principle 3, ASX Principles.
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Guideline 18 of the Investment and Financial Services Association’s Guide for Fund Managers and Corporations Corporate Governance suggests that listed companies should have a company code of ethics and conduct that is adopted by the board and is available to shareholders on request.
Most large corporations around the world have responded to calls such as these and have developed codes of ethics. Research conducted by Mark Schwartz119 reveals that the percentage of large corporations having a code of ethics is over 90 per cent in the USA, 85 per cent in Canada, 57 per cent in the UK, 51 per cent in Germany and 30 per cent in France (although some of these statistics date back as far as 1990).
Codes of ethics are becoming increasingly common in Australia,120 perhaps because of the emphasis placed on them in a number of reports concerning corporate governance. For example, the Bosch Committee’s report on Corporate Practice and Conduct (now in its third edition) recommends guidelines for the conduct of directors and also a company code of ethics addressing such matters as responsibilities to shareholders, customers and even to the community (for example, with respect to an environment policy).
Schwartz suggests that companies use codes for a number of reasons, ‘including the provision of consistent normative standards for employees, avoidance of legal consequences, and promotion of public image’.121 He goes on to say that, despite their prevalence, many still question the need for them.122
A number of commentators regard codes of conduct as having only a limited deterrent effect. Others regard them as having a negative effect. One commentator123 goes so far as to say that codes of ethics have been shown to be insufficient and unnecessary and might mask failures in organisational structures that will influence behaviour.
H and J Rockness are among the doubters.124 They illustrate what they take to be the limited deterrent value of codes of conduct by reference to CEO salaries (on the assumption that greed overcomes integrity). They say in this respect that, despite codes of conduct and penalties,
119 Schwartz, above n 72, 248; M Schwartz, ‘A Code of Ethics for Corporate Code of Ethics’ (2002) 41 Journal of Business Ethics 27. 120 See in this respect the discussion by Le Mire, above n 54, 314. 121 Schwartz, above n 72, 248. 122 Schwartz, above n 72, 248. 123 H S James Jr, ‘Reinforcing Ethical Decision Making through Organisational Structure’ (2000) 28 Journal of Business Ethics 43, quoted by Cordery, above n 12, 65. 124 H and J Rockness, above, n 52, 50.
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‘greed, personal gain, and pursuit of power prevailed in many of the cases of the 1990s’.125 They mention that the average CEO pay was 42 times average production-worker pay in 1982 but had grown to 530 times average production-worker pay by 2000 and that stock options or other performance-based pay had grown to 80 per cent of CEO compensation. Their premise is that ‘legislation, controls, and cultural norms did not deter corporate unethical behavior by some because of the potential for enormous personal gain’.
Andrew Felo126 refers to empirical studies concerning the relationship between ‘negative behaviour’ and ethics programs. One of these,127 using managers and corporate controllers as subjects, found no significant relationship between the likelihood of fraudulent financial reporting and codes of conduct.
Painter-Morland128 says that codes of conduct are often perceived by internal and external stakeholders as window dressing or as public relations exercises that have no real effect on ‘business as usual’. She goes on to say:
The objections that are raised against codes in business ethics discourses range from a critique of their intent and the implications of their promulgation, to realistic assessments of their use… Researchers point out that since many codes are promulgated to comply with regulatory demands, or to reduce companies’ legal risks, they induce only routinized compliance… Codes that are primarily drawn up to limit a company’s legal liabilities therefore tend to reflect little of what is really valued by, or expected of, those who participate in an organizational system. Schwartz concurs that codes are mostly inward-looking, i.e. aimed at behavioral conformity… As such, they do little to stimulate moral discretion. In fact, the kind of behavioral conformity that they advocate discourages moral responsiveness by undermining individual autonomy.129
She refers to a study130 that found that the presence of an ethical code had a negative effect on individual ethical decision making. She says, in this respect:
125 H and J Rockness, above, n 52, 50 126 Felo, above n 75, 207. 127 A Brief, J Dukerich, P Brown and J Brett, ‘What’s Wrong with the Treadway Commission Report? Experimental Analyses of the Effects of Personal Values and Codes of Conduct on Fraudulent Financial Reporting’ (1996) 15 Journal of Business Ethics 183. 128 Painter-Morland, above n 73, 12; see also Joshua Newberg, ‘Corporate Codes of Ethics, Mandatory Disclosure, and the Market for Ethical Conduct’ (2004) 29 Vermont Law Review 253, 265. 129 Painter-Morland, above n 73, 23. 130 A Pater and A Van Gils, ‘Stimulating Ethical Decision Making in a Business Context: Effects of Ethical and Professional Codes’ (2003) 21 European Management Journal 762, 772.
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Their explanation for this counter-intuitive finding is that the existence of control mechanisms and rules don’t [sic] affect the ethical attitudes that actually inform behavior. The fact that code content is often commonsensical may indeed insult employees’ intelligence. Providing more detail in codes of conduct may also be counterproductive, as it leaves no room for individual discretion. In fact, a heavy reliance on rules and policies may bring individuals to the conclusion that if something is not strictly forbidden, it is permissible. There are various other authors who attribute the indifferent attitudes of employees to codes to the fact that people believe themselves capable of distinguishing right from wrong without the guidance of a code. ... A further problem regarding codes relates to the way in which they are used. Research has shown that though a very large percentage of organisations have codes, a much smaller percentage of employees are aware of their existence and an even smaller number are versed in their content…This study also found that the existence of a code was unlikely to have an effect on an employee’s decision to report observed unethical behaviour…131
She suggests that placing too much emphasis on deliberate, principled reasoning in ethics training programs limits the ability to insert ethics into the normal, everyday concerns of business practice and effectively enforces a separation between theory and practice.132 She says that this kind of approach ‘contributes to the impression that ethical considerations are checks on business practice, rather than a normal part of everyday business practice’.133 She argues that ‘these developments have created a US corporate environment in which compliance takes precedence over ethics’ and that the ‘heavy emphasis’ placed on compliance ‘has significantly colored many people’s perception of the value of ethics and has left it with a very narrowly circumscribed role.’ 134
In 2003, the US Conference Board’s Commission on Public Trust and Private Enterprise published a report with respect to corporate governance issues. The report concludes that ethical codes, alone, are not enough. The report stresses the importance of the development and enforcement, by board committees, of an ethical working environment and suggests that ethics should feature in performance evaluation.
The NAB foreign exchange trading scandal graphically illustrates the proposition that codes of conduct are inadequate, by themselves, to prevent unethical conduct. The bank’s employees were required to sign codes of conduct requiring ‘the highest level of honesty and integrity’ and also compliance with any ethical requirements of regulatory or professional bodies to which they belonged. It also had a 10 page set of governance guidelines. Its corporate governance structures were given
131 Painter-Morland, above n 73, 24. 132 Painter-Morland, above n 73, 29. 133 Painter-Morland, above n 73, 30. 134 Painter-Morland, above n 73, 31.
152 JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED? a five star rating by the Howarth Corporate Governance Report 2003.135 Cordery comments that, ‘despite its code of ethics and accolades for board structures, the NAB board was criticised for an emphasis on profit and asking few questions about risk when ready profit seemed to be available’.136
I have earlier mentioned that AWB was not protected by its code of conduct, which disapproved of illegal payments and instructed employees not to make payments that were unethical or likely to ‘cause embarrassment to the Company’.137 Derek Parker suggests that one of the lessons of corporate governance that can be learned from the AWB scandal is that ‘a written set of guidelines means nothing if it is not supported by the implicit signals from the board and the senior management’. He says that if there is ‘a clash between a code of conduct and ingrained corporate culture, the latter is nearly certain to prevail’.138
Others have complained about the cost of adopting corporate codes and the compliance programs that inevitably accompany them.139 Robert Cameron, an Auckland based investment banker, has been quoted as saying that New Zealand’s equity capital markets are robust and responsive, with institutional investors, market analysts and shareholder advocates taking an increasing interest in the quality of firms’ governance; that the corporate controlled market is ‘alive and well’; that the market, in New Zealand, for managerial and director talent is ‘thin’; that its corporations are small by international standards, with compliance costs having a relatively large impact on profitability and value; and, consequently, that there should be caution about further regulating corporate governance.140 He has been quoted as going on to say:
Simply put, specific regulation of corporate governance practices holds major risks for the open corporation compared to an environment which provides and enforces adequate rights and protection for all shareholders and clearly specifies responsibilities, fiduciary duties and liabilities of directors, requires accurate and timely reporting, and supports robust and responsive equity capital and corporate control markets.141
135 See Cordery, above n 12, 65. 136 Cordery, above n 12, 65. 137 Le Mire, above n 54, 313. 138 Parker, above n 35, 30. 139 H Pitt and K Groskaufmanis, ‘Minimising Corporate Civil and Criminal Liability: A Second Look at Corporate Codes of Conduct’ (1990) 78 Georgetown Law Journal 1559 and others, all of whom are quoted by Schwartz, above n 72, 248. 140 See Reg Birchfield, ‘Corporate Governance; Private Thoughts - Is the Tide Turning?’ (July 2005) New Zealand Management 70. 141 Birchfield, above n 140.
153 (2010) 12 UNDALR He is said to have warned that private equity poses a ‘real threat’ to public corporations and that the ability of private organisations to attract top-level talent is enhanced by their ability to reward them well, to operate away from the glare of publicity and (implicitly) to avoid the consequences of overregulation suffered by public companies.
C More (and Better Qualified) Independent Directors
I have said that independent directors generally protect the interests of shareholders better than ‘inside’ or ‘grey’ directors. They are also more likely to give effect to the needs of corporate social responsibility in the sense of taking into account interests and values regarded by the general community as important. Finally, there is evidence to support the proposition that there are less cases of fraud in financial reporting when companies have independent directors.142
There has consequently been general acceptance of the proposition that listed companies should have a majority of independent directors.143 This is the recommendation made by the ASX Principles. Recommendations 2.1 and 2.2 respectively provide that a majority of the board and the chairperson should be independent directors. Recommendation 2.3 suggests that the positions of chairperson and CEO should be held by different individuals. For the purposes of these principles, an independent director is a non-executive director who:
(1) is not a substantial shareholder of the company or officer of, or otherwise associated directly with, a substantial shareholder of the company;
142 See, M Beasley, J Carcello, D Hermanson and P Lapides, ‘Fraudulent Financial Reporting: Consideration of Industry Traits and Corporate Governance Mechanisms’ (2000) 14 Accounting Horizons 441; P Dunn, ‘The Impact of Insider Power on Fraudulent Financial Reporting’ (2004) 30 Journal of Management 397; these are cited by H Kang, M Cheng and S Gray, ‘Corporate Governance and Board Composition: Diversity and Independence of Australian Boards’ (2007) 15 Corporate Governance 194, 197. 143 See, for example, the report prepared by the Cadbury Committee in the UK (Committee on Financial Aspects of Corporate Governance) on 1 December 1992, the Bosch Committee report on Corporate Practices and Conduct, the Higgs report in the UK, Review of the Role and the Effectiveness of Non-Executive Directors, January 2003, the UK Financial Reporting Council’s Combined Code that came into effect on 1 November 2003, the OECD’s Principles of Corporate Governance approved in April 2004, the Investment and Financial Services Association’s corporate governance guide titled Corporate Governance: A Guide for Fund Managers and Corporations (all of which are referred to in Austin, Ramsay and Ford, Ford’s Principles of Corporations Law [7.650]) and the Australian Government Productivity Commission Report No 49, above n 89.
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(2) within the last three years has not been employed in an executive capacity by the company or another group member, or been a director after ceasing to hold any such employment; (3) within the last three years has not been a principal of a material professional adviser or a material consultant to the company or another group member, or an employee materially associated with the service provided; (4) is not a material supplier or customer of the company or other group member, or an officer of or otherwise associated directly or indirectly with a material supplier or customer; (5) has no material contractual relationship with the company or another group member other than as a director of the company; (6) has not served on the board for a period which could, or could reasonably be perceived to, materially interfere with the director’s ability to act in the best interests of the company; (7) is free from any interest and any business or other relationship which could, or could reasonably be perceived to, materially interfere with the director’s ability to act in the best interests of the company.144
Helen Kang, Mandy Cheng and Sidney Gray recently conducted a study of 100 of the largest publicly listed Australian companies by market capitalization.145 Assessing the independence of each director according to the seven point definition just referred to, they found that, of a total of 820 directors, 530 were independent. Seventy-three companies had an independent chairperson and another 16 had a non-executive chairperson.146 These figures are encouraging. (Less encouraging is their finding that only 85 of the 820 directors were female, 15 of them holding positions in more than two companies and seven holding positions in more than four companies.)147
More recently, in 2008, Korn/Ferry International and Egan Associates released a study of 300 leading Australian companies and 50 leading New Zealand companies.148 This revealed that, in the case of the Australian companies (all of which were listed), the boards had an average of seven directors, 74.1 per cent of whom were non-executive (and 8.3 per cent of whom were women). Ninety-five per cent of these companies had an audit committee and 88 per cent had a remuneration committee.
144 See Kang, Cheng and Gray, above n 142, 205. 145 Kang, Cheng and Gray, above n 142, 205. 146 Kang, Cheng and Gray, above n 142, 199. 147 Kang, Cheng and Gray, above n 142, 200. 148 See, Austin, Ramsay and Ford, above n 143, [7.640].
155 (2010) 12 UNDALR Even a minority of independent directors will tend to act as a brake on corporate misfeasance, assuming, of course, that they are capable, informed, active and strong. Unfortunately, that is not always the case, even when independent directors are in the majority. Jane Simms, writing about the recent financial crisis that threatened the banking community in the city of London, mentions that the UK Financial Reporting Council’s Combined Code on corporate governance (which came into effect on 1 November 2003 and applied to non-executive bank directors, amongst others) stated that:
where directors have concerns that cannot be resolved about the running of the company or a proposed action, they should ensure that their concerns are recorded in board minutes. On resignation, a non-executive director should provide a written statement to the chairman, for circulation to the board, if they have any such concerns.149
She quotes a former bank director as explaining the absence of resignations by non-executive directors in the run up to the banking crisis ‘as a result either of their capitulation to bullying executives or to a lack of understanding about the products banks were selling and the risks they were running’.150 She also quotes an expert151 in corporate governance as going so far as to say:
A big issue is that boards are in thrall to the chief executive. And because there is insufficient diversity, group psychology sets in and there is no incentive to rock the boat. Every big organisation, including banks, should have a psychotherapist on the board to stop people becoming ‘captive’ and losing their objectivity.152
I have said that independent directors (assuming that they are of the necessary calibre) are more likely to be conscious of the need to be socially responsible. The importance of this is illustrated by the 1996 study, mentioned earlier,153 into the massive social costs to the community arising out of US corporate and other business activity. Another example is provided by the need to minimise emissions in an attempt to counteract, or at least reduce the consequences of, global warming. A society in which good moral behaviour is regarded as necessary only when legislated for is as undesirable in the corporate and business world as it is in the case of ordinary people. The Aristotelian ideal that the ultimate aim of human existence is a happy life and that a happy life is one that is achieved by doing good things154 might be far removed from ordinary corporate ideology in a competitive and
149 J Simms, ‘Flaws at the Top’, Director, London, December 2008, Vol 62, Issue 5, 46. 150 Simms, above n 149, 47. 151 Sarah Wilson, chief executive of corporate governance expert, Manifest. 152 Simms, above n 149, 48. 153 R Estes, Tyranny of the Bottom Line (1996), quoted by Schwarz, above n 72, 247. 154 Discussed by Painter-Morland, above n 73, 75-76.
156 JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED? profit oriented world, but there is a balance to be struck - andthose directors who are less dependent on the bottom line are more likely to strike it. However, they will only do so if they have the requisite moral values, if they are not under the spell of the CEO and if they understand the business of the company. They are also obliged to think for themselves. As James Hardie shows,155 they cannot abdicate responsibility by delegating to a fellow director.
Of course, even independent directors are answerable to shareholders. However, the notion of ethical investment has gained some ground. For example, in Australia, over 40 per cent of the top 20 superannuation funds have an SRI (sustainable and responsible investment) strategy.156 One of these, VicSuper, has formed a consortium called ‘Investors 157 Group on Climate Change’. D More Effective Audit Committees
It would be wrong to treat all unanticipated corporate failures as audit failures. The principal responsibility for the provision of accurate financial information rests squarely with management.158 The importance of internal auditing has consequently been increasingly recognised.159
Joe Christopher, Gerrit Sarens and Philomena Leung, writing in the Accounting, Auditing & Accountability Journal, mention that the primary goal of an internal auditor is objectivity. They go on to say:
This can only be achieved if the internal audit function is appropriately placed in the organisational structure. …[C Chapman, ‘Raising the bar - Newly revised standards for the professional practice of internal auditing’, Internal Auditor, Vol 58 No 21, 55] describes organisational independence as the placement of the internal audit function in the reporting structure so that it is free to determine the audit scope and perform audit work without interference. … [M Bariff, ‘Internal Audit Independence and Corporate Governance’, Institute of Internal Auditors Research Foundation, Altamonte Springs, FL (2003)] underlines the way in which the internal audit function can maintain independence from management by noting the following quote from a PricewaterhouseCoopers report:
155 Australian Securities and Investments Commission v Macdonald (No 11) (2009) 256 ALR 199, [260]-[261]. 156 Spiller, above n 71, 47. 157 Spiller, above n 71, 47. 158 Section 296 of the Corporations Act 2001 (Cth) imposes a duty on directors to ensure that financial records comply with accounting standards. See also V Nguyen and P Rajapakse, ‘An Analysis of the Auditors’ Liability to Third Parties in Australia’ (2008) 37 Common Law World Review 9, 14-15. 159 See, for example, Joe Christopher, Gerrit Sarens and Philomena Leung, ‘A Critical Analysis of the Independence of the Internal Audit Function: Evidence from Australia’ (2009) 22 Accounting, Auditing and Accountability Journal 200, 201.
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‘Internal audit departments need to ensure an organisational posture which allows them to operate successfully on strategic issues. This means both the independence and mandate to deal with significant strategic business risks and issues. If inappropriately positioned within the company, internal audit deals with tactical issues and is viewed only at that level. Inappropriate positioning can also raise serious concerns about the overall independence of the function (PWC, 2002).’160
They identify161 a number of threats to independence and effectiveness. These include using the internal audit function as a stepping stone to other positions; having the CEO or CFO (Chief Financial Officer) approve the budget of the internal audit committee or provide input for the internal audit plan; treating the internal auditor as a ‘partner’; having chief audit executives not reporting functionally to the audit committee; the audit committee not having sole responsibility for appointing, dismissing and evaluating the chief audit executives; and not having all audit committee members, or at least one of them, qualified in accounting.
E Auditors
The Corporations Act 2001 (Cth), following amendment in 2004, has a large number of provisions designed to prevent auditors from acting as such in cases of conflict of interest. The legislation largely follows recommendations made by the HIH Royal Commission162 and in the Ramsay Report.163
A ‘conflict of interest situation’ is defined in s 324CD. The definition applies to all professional members of the audit team, as defined in s 324AE. There are also detailed separate provisions (in s 324CH) prohibiting auditors, and members of an audit firm, from conducting audits in a relatively large number of specified circumstances (for example, where an officer or employee of the audited company is connected with the auditor in such a way as to enable that person to influence the audit or where the person in question was an officer of the audited body during the period to which the audit relates, or 12 months prior thereto, or during the period in which the audit is being conducted or the audit report is being prepared).
160 Christopher, Sarens and Leung, above n 159, 203. 161 Christopher, Sarens and Lueng, above n 159, 214. 162 Commonwealth of Australia, HIH Royal Commission, Report of the Royal Commission into the Failure of HIH Insurance (2003). 163 Ian Ramsay, ‘Independence of Australian Company Auditors: Review of Current Australian Requirements and Proposals for Reform’ (October 2001), report delivered to the Minister for Financial Services and Regulation.
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Unlike the Sarbanes-Oxley Act in the USA, there is no prohibition against an auditor providing non-audit services to the company audited, at least absent a connection of the kind identified by s 324CH. The legislature was content, in this respect, to impose stringent disclosure requirements: s 300(11A), enacted after considering recommendations in the Ramsay and HIH Royal Commission reports. The reason for this was explained in the Explanatory Memorandum prepared in respect of the CLERP 9 Bill, which introduced the amending provisions. Paragraph 4.43 of the memorandum identifies what seems to me to be a rather doubtful distinction. It suggests that ‘the provision of non- audit services per se does not compromise independence but rather it is the possibility of dependence on the financial stream flowing from those services’. It also mentions the importance of audit firms being able to attract specialists, stating (para 4.47):
Attracting and retaining these specialists, and motivating them to provide direct audit support, may be hampered if they were to be prohibited from providing non-audit services to clients. On some occasions it may be advantageous to the company and shareholders for the auditor to provide non-audit services, particularly where that service benefits from an intimate knowledge of the business. Therefore, an unintended consequence of a prohibition on auditors providing non-audit services to their clients could be to reduce the effectiveness of business advisory services received by the company.
There are other significant provisions, too numerous to be dealt with here. These include provisions concerning waiting periods before retired partners of audit firms, and some retired professional employees of audit firms, may be employed as a director or officer of the audited body (s 324CI and s 324CJ, introduced pursuant to a recommendation by the HIH Royal Commission, although it had recommended a longer waiting period than that adopted) and provisions requiring rotation, in the case of audits of listed companies, of persons playing ‘a significant role’ in the audit for five successive years (s 324DA).
Also, Listing Rule 12.7 requires each company in the Standard & Poor’s ASX All Ordinaries Index to have an audit committee; and the top 300 of those companies must ensure that the committee consists only of non- executive directors, the majority of whom must be independent, and chaired by an independent person who is not chairperson of the board. The ASX recommends, in its commentary on Recommendation 4.2 of the ASX Principles, that the audit committee should include members who are financially literate, one of whom has relevant qualifications and experience, and that some members should have an understanding of the industry in which the entity operates.164
164 See generally, in respect of these and other recommendations and legislative provisions, Austin, Ramsay and Ford, above n 143, [10.450]-[10.670].
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F Whistleblower Protection
Whistleblower protection is an important part of any ethical compliance program. In the absence of protection for whistleblowers, unethical conduct will not be reported. Even then, there is unlikely to be any report unless the recording of unethical conduct is actively (and genuinely) encouraged. Paul Latimer and A J Brown165 suggest that best practice is for the employer to bring whistleblower policy to the attention of employees, including their duty to disclose illegality, and to notify them of the existence of protection and support services for whistleblowers. They go on to say:
The true value of whistleblowing is often hard to recognise within an organisation, especially at the time. Whistleblowers are often more easily seen, at least initially, as traitors rather than heroes. Seen as a traitor, a whistleblower may suffer discrimination and victimisation, further underpinning why whistleblowing legislation focuses strongly on the promotion of a culture where honest disclosures are not punished but are respected and valued, and on legal protection from reprisal, punishment or retribution.166
A study conducted by Mark Somers found that the existence of a code of conduct, of itself, was unlikely to influence the decision of an employee whether or not to report unethical behaviour.167 As early as 1977 the Treadway Commission in the USA168 recommended that there be whistleblower programs with access to the board of directors. A Whistleblowers Protection Act was enacted in 1989. However, a US study conducted in 1994 by the Ethics Resources Centre169 found, after interviewing over 4,000 employees, that 30 percent had observed violations of the law or company policy over the preceding year, but less than half of them had reported the misconduct to an appropriate person in the company.
The US 2003 Conference Board’s report (mentioned above, when addressing codes of conduct) referred to studies that have found that whistleblowers were often fired or demoted as a result of their efforts. It stressed the need for a safe environment for the reporting of ethical issues.
165 Paul Latimer and A J Brown, ‘In whose Interest? The Need for Consistency in to Whom, and about Whom, Australian Public Interest Whistleblowers can make Protected Disclosures’ (2007) 12 Deakin Law Review 1, 4. 166 Latimer and Brown, above n 165. 167 Mark Somers, ‘Ethical Codes of Conduct and Organizational Context: A Study of the Relationship between Codes of Conduct, Employee Behaviour and Organizational Values’ (2001) 30 Journal of Business Ethics 185, referred to by Painter-Morland, above n 73, 25. 168 Referred to by H and J Rockness, above n 52, 50. 169 Ethics Resource Center (1994), Ethics in American Business: Policies, Programs and Perceptions (Washington DC), quoted by Schwartz, above n 74, 247.
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Section 301 of the Sarbanes-Oxley Act 2003 made the institutionalization of whistleblower protection compulsory. However, as Painter-Morland points out,170 it is one thing to have a whistleblowing line and another to get employees to use it. She suggests that research has demonstrated that supervisory status is the most consistent predictor of whistleblowing and that the existence of a policy that encourages whistleblowing also plays a role. She concludes that people are more likely to report misconduct if they feel that it is their responsibility to do so.171
While whistleblower protection exists in Australia,172 there is no reason to conclude that the position here is any different from that in the USA.
G Executive Remuneration
The issue of executive remuneration attracted the interest of The Group of Twenty (‘G-20’) leaders at their meeting in September 2009. A statement issued by them concerning the global financial crisis suggested that excessive remuneration in the financial sector had reflected and encouraged excessive risk-taking. They regarded itas essential to reform remuneration policies and practices.
A similar conclusion was arrived at in the Report of the High Level Group on Financial Supervision in the EU (European Union) published in 2009.173 One of the problems identified in that report (which investigated causes of the recent financial crisis) was that remuneration practices within many financial institutions contributed to excessive risk-taking by rewarding short-term expansion of risky trading rather than long-term profitability of investments. (See also the report prepared by Lord Turner, chairman of the UK Financial Services Authority, titled ‘A Regulatory Response to the Global Banking Crisis’ (March 2009) and the report prepared by David Walker, ‘A Review of Corporate Governance in UK Banks and Other Financial Industry Entities’ (July 2009).)174
170 Painter-Morland, above n 73, 40. 171 Painter-Morland, above n 73, 42. 172 See, for example, s 1317AA of the Corporations Act 2001 (Cth) (introduced, in 2004, by the CLERP 9 Act), Part 4A of Schedule 1, Chapter 11 of the Workplace Relations Act 1996 (Cth) (also introduced in 2004), s 16 of the Public Service Act 1999 (Cth) and the various State laws with respect to public interest disclosures and whistleblowers protection (these are discussed by Latimer and Brown, above n 165, 5ff, 20 who conclude that the differences and inconsistencies between existing instruments demonstrate a clear need for reform). 173 Referred to in Austin, Ramsay and Ford, above n 143, [7.700]. 174 Also referred to in Austin, Ramsay and Ford, above n 143, [7.700].
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As matters stand in Australia, s 300A of the Corporations Act 2001 (Cth) requires that the directors’ report for companies listed on the ASX to include details of elements of remuneration that depend on the satisfaction of performance conditions and discussion of board policy for determining the nature and amount of remuneration of board members and senior managers.
Also, the ASX Principles encompass the proposition (part of Principle 8) that companies should balance the desire to attract and retain senior executives and directors against their interest in not paying excessive remuneration. The Council recommends (Recommendation 8.1) that the board should establish a remuneration committee.
I have earlier mentioned the Productivity Commission’s January 2010 report. In that report, the Commission ruled out capping executive pay. It considered that this, or introducing a binding shareholder vote on pay, would be impractical and costly. Instead, it said that the corporate governance framework should be strengthened by:
removing conflict-of-interest, through independent remuneration committees and improved processes for use of remuneration consultants; promoting board accountability and shareholder engagement, through enhanced pay disclosure and strengthening the consequences for those boards that are responsible to shareholders ‘say on pay’.175
The Commission made a number of other key recommendations. It is beyond the scope of this article to list these, save that I should draw particular attention to Recommendation 15, to the effect that the Corporations Act 2001 (Cth) should be amended such that:
• where a company’s remuneration report receives a ‘no’ vote of 25 per cent or more of eligible votes cast at an annual general meeting (‘AGM’), the board be required to explain in its subsequent report how shareholder concerns were addressed and, if they have not been, the reasons why;
• where the subsequent remuneration report receives a ‘no’ vote of 25 per cent or more of eligible votes cast at the next AGM, a resolution be brought that the elected directors who signed the directors’ report for that meeting stand for re-election at an extraordinary general meeting (the re-election resolution). Notice of the re-election resolution would be contained in the meeting papers for that AGM. If it were carried by more than 50 per cent of eligible votes cast, the board would be required to give notice that such an extraordinary general meeting will be held within 90 days.
175 Australian Government Productivity Commission Report No 49, above n 89, xiv.
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V What More Should Be Done?
A Corporate Governance
Legislative interventions have been beneficial, although, as I have said, legislation can never provide a complete answer to corporate misbehaviour and there is a risk of overregulation. The same is true of codes of conduct, although these can be helpful, if they are part of a wider internal ethics program.
Harvey and Le Mire suggest176 that the task of developing a code of conduct can encourage employees of a corporation to focus on ethical issues and to serve as ‘external and internal signalling devices’177 to show that ethical behaviour is valued. Schwartz178 refers to several theorists who have suggested that ethical decision-making or behaviour can be influenced by a code of ethics (although his conclusion is that the research remains inconclusive regarding the impact of codes of behaviour,179 at least if viewed in isolation).
What is needed, though, is a comprehensive ethics program that is designed to breathe life into a code.
The Federal Sentencing Guidelines for Corporations in the USA describe seven steps that should be taken when establishing an ethics and compliance program. These are:180
(1) formulating compliance standards and procedures such as a code of conduct or ethics; (2) assigning high-level personnel to provide oversight (eg, a compliance or ethics officer); (3) taking care when delegating authority; (4) ensuring that there is effective communication of standards and procedures (eg, training); (5) developing auditing/monitoring systems and reporting mechanisms and facilitating whistle-blowing; (6) enforcement of disciplinary mechanisms; and (7) ensuring that there is an appropriate response after detection.
If an ethics program is to succeed, it has to be seen by corporate employees to be genuine and important. It is consequently essential
176 Harvey and Le Mire, above n 54, 182. 177 They quote Newberg, above n 129, 269. 178 Schwartz, above n 72, 248. 179 Schwartz, above n 72, 249. 180 The summary is taken from Painter-Morland, above n 73, 6.
163 (2010) 12 UNDALR that senior management, and the board, are, and are seen to be, committed to it. Felo suggests that:
If employees perceive that a firm’s upper management is committed to a corporate initiative, then it is more likely that they will “buy into” the initiative. Outside parties may perceive that the board’s involvement increases the likelihood that the program will be taken seriously within the firm and is not just ‘window dressing’.181
It is not only outsiders who will regard an ethics program as ‘window dressing’ if it is not taken seriously at board and senior management level. Employees will also do so. Also, if there is no genuine stress on an ethical culture as opposed, simply, to reliance on a written code, there is a real risk that wider ethical principles will be subsumed into reliance on the wording of the code. Painter-Morland says, in this respect, that:
The approach to business ethics that is currently being extolled in many business and academic forums may implicitly be contributing to the dissociation of ethics with business practice. Ethics is portrayed as a set of principles that must be applied to business decisions. In this conception, ethics functions as a final hurdle in a deliberate decision-making process. The questions that inform this process are usually something along the line of: “May we do this?” or even more cynically: “Can we get away with this?” When approached in this way, ethics becomes something that people consider after they have interpreted events and determined what they want to do. When ethics functions as an integral part of business practice, however, it informs individuals’ perceptions of events from the start and plays an important part in shaping their responses. This kind of ethics is not based on the deliberate application of general principles, but draws instead on tacit knowledge and individual discretion. The kinds of questions that ethics as practice would have us ask are of a decidedly different order. It asks us to consider: ‘How do we want to live?’ and: ‘Who do we want to be?’ When an organization’s investment in business ethics becomes a mere insurance policy, really meaningful and significant questions such as these are never raised or addressed.182
In the concluding pages of her book, she goes on to say:
The main argument of this book has been that ethics should be part of everyday business practice and not mere compliance with legislation and regulations. If ethics is something that has to be attended to only because legislation or regulation calls for it, it is positioned as a trade-off, as something that has to be done in order to be allowed to get on with business-as-usual. When this is the case, organizations simply ask themselves: what do we have to put in place to comply? Consequently, they spend as little time, money and effort on their ethics programs as they think they can get away with. If ethics programs are designed and implemented with this kind of mindset, they are likely to suffer from a number of serious defects. In the first place, they will lack legitimacy. Those to whom they are supposedly addressed will soon recognize them for what they are: mere window-dressing exercises. Such ethics programs are also unlikely to influence people’s sense of normative orientation or affect the way in which they understand and exercise their moral agency. Finally, there is little chance that
181 Felo, above n 75, 207. 182 Painter-Morland, above n 73, 2.
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ethical programs of this nature could effect an integration of ethics into people’s everyday working lives. Institutionalizing codes, policies and various kinds of checks-and-balances may seem reassuring from a compliance perspective, but it is unlikely to have any meaningful effect on the moral responsiveness of those who participate in organizational systems.183
When considering how to break out of this compliance mindset, Painter-Morland suggests that the emphasis on money must be shifted. She says:
Money, and the things that it can buy, give people a sense of identity and make them feel valued and respected. The irony is that many people lose themselves, destroy their relationships, and harm their communities in the single-minded pursuit of money. We therefore need to rethink the relationships between people’s sense of themselves, their sense of urgency, and the things that they value in life. It is in, and through, the interactions between our sense of self, the power relationships in which we function, and the truths that we tacitly possess, that the fabric of morality is woven.184
Michael Lotzof, the CEO of the Australasian Compliance Institute, adopts a broadly similar approach. He says:
Compliance will be perceived as an unnecessary burden if it is perceived that it exists solely to satisfy regulators; if it operates by impeding growth through slowing and even frustrating decision-making; if its systems, processes, reviews, and information provide no direct benefit back to the business. A compliance framework should be designed to support the organization’s strategic imperatives and to help the organization behave in a way that is consistent with its core values.
The systems and process of compliance should wherever possible be part of the normal systems of the business. In the ideal world the implemented controls should be those that the business would want so it can effectively manage itself, and the information provided to compliance should be in the main sub-sets of what is normal reporting.
The culture should be one that business would strive to create to improve stakeholder relationships and work practices - to do good business well.185
Good compliance does not equate to bad business. It should lift morale and improve reputation. A recent study by a European researcher186 concludes that there is a positive relation between the extent of compliance with international best practices on various governance dimensions (board structure and functioning, disclosure on corporate governance) and the operating performance of European companies.
183 Painter-Morland, above n 73, 290-292. 184 Painter-Morland, above n 73, 291. 185 Lotzof, above n 112, 76. 186 H Van der Bauwhede, ‘On the Relation Between Corporate Governance Compliance and Operating Performance’ (2009) 39 Accounting and Business Research 497.
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B Auditors, Accountants and Lawyers
Corporate misconduct, at least of the more sophisticated kind, becomes a lot harder if strong (and strongly enforced) rules preclude lawyers and accountants from lending their aid to it, whether by closing their eyes (and sealing their lips) or otherwise.187
I have already addressed the issue of auditors. Self-evidently, if they have a direct or indirect interest in the company they are auditing (whether through the provision of non-audit services or otherwise), there is an increased risk that the auditors will have an incentive to scrutinise corporate records, especially financial records, less closely than they might otherwise have done. This has led to universal acceptance of the proposition that auditors should not identify themselves with the company audited and that companies should have audit committees consisting of at least a majority of independent directors.188
Legislative and regulatory interventions in respect of auditors have been beneficial, but, again, they are not enough on their own. Accounting firms, like the bodies they audit, have an obligation to develop a corporate culture, starting at the top, which encourages ethical behaviour, that is supervised by senior management and that requires auditors at any level to be vigilant in reporting anomalies. There has to be reinforcement of an understanding that their task is one that is not performed for self- interest, but in the interests of shareholders and of the wider community. That simple message has to be drilled into those learning their profession, from the outset of their studies and again, from time to time, after they have embarked upon professional practice.
When corporations are guided by their lawyers, the guidance ordinarily takes the form of advice on the issue of what can or cannot be done rather than what should or should not be done. I have said that (with some justification) lawyers see their role as that of advising on the law and not in respect of moral values. One commentator (formerly a lawyer) has said that:
With compliance in the hands of legal advisors…, the question often was ‘what can I get away with?’ Rather than ‘what is the right thing to do?’
187 I am not suggesting, here, that the liability of professional advisors to third parties should be enhanced. Some commentators suggest that auditors, in particular, are already subject to a greater scope of liability in Australia than in other countries: see, for example, Nguyen and Rajapakse, above n 158, 9. 188 See, for example, the Combined Code, above n 143, the US Conference Board’s Commission Report, ASX Listing Rule 4.10.3 and the ASX Principles, each of which is discussed in Austin, Ramsay and Ford, above n 142, [7.660].
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After a breach, lawyers circled the wagons, [and] applied legal “first aid” rigorously defending the ‘patient’ against the attacking regulatory hordes.189
Although lawyers are not the keepers of the public morals, or even expected to give advice concerning issues of morality, and although it is their duty to defend the ‘patient’ when attacked by prosecuting bodies, they are officers of the court and their primary duty is owed to the administration of justice.190 They do not always fulfil this duty. An illustration of this appears from the judgment of Kessler J in United States v Philip Morris USA Inc 449 where he said:
Finally, a word must be said about the role of lawyers in this fifty-year history of deceiving smokers, potential smokers, and the American public about the hazards of smoking and second hand smoke, and the addictiveness of nicotine. At every stage, lawyers played an absolutely central role in the creation and perpetuation of the Enterprise and the implementation of its fraudulent schemes. They devised and coordinated both national and international strategy; they directed scientists as to what research they should and should not undertake; they vetted scientific research papers and reports as well as public relations materials to ensure that the interests of the Enterprise would be protected; they identified “friendly” scientific witnesses, subsidized them with grants from the Center for Tobacco Research and the Center for Indoor Air Research, paid them enormous fees, and often hid the relationship between those witnesses and the industry; and they devised and carried out document destruction policies and took shelter behind baseless assertions of the attorney-client privilege. What a sad and disquieting chapter in the history of an honorable and often courageous profession.191
It is not difficult to find other illustrations. As Harvey and Le Mire point out:
The James Hardie corporate scandal … is another recent example of this dynamic. In that case, lawyers were involved in the creation, implementation and defence of a scheme which had, at its heart, the desire to shake off liabilities to workers who had suffered injuries due to asbestos exposure while working for James Hardie subsidiaries: New South Wales, Special Commission of Enquiry into the Medical Research and Compensation Foundation, Final Report (2004).192
Harvey and Le Mire193 go on to say, in this context, that:
It is clients who pay the lawyers’ bills and the ethic of doing what you can for your client may mean that lawyers are overly solicitous of clients’ views…
The primary response where lawyers abuse process is the disciplinary sanctions contained in each state’s legislation regulating lawyers. Disciplinary proceedings, however, rarely consider breaches of a duty to the administration of justice, as
189 Lotzof, above n 112, 73. 190 See, for example, Giannarelli v Wraith (1988) 165 CLR 543, 555-556 and Rule 2.2(a) Law Society of WA Professional Conduct Rules. 191 United States v Philip Morris USA Inc 449 F Supp 2d 1, 4-5 (DDC, 2006), as mentioned by Harvey and Le Mire, above n 54, 170. 192 Harvey and Le Mire, above n 54, 178. 193 Harvey and Le Mire, above n 54.
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the disciplinary process is generally driven by client complaints. In the case where a lawyer acts overzealously in the client’s favour there is unlikely to be a client complaint. Even if the client is unhappy, as large corporate clients, they are likely to have alternative ways of disciplining their lawyers, particularly where those lawyers are ‘in-house’. While disciplinary regulators have the power to consider complaints from other sources, or indeed to commence proceedings spontaneously, this rarely occurs. This may in part be due to the daunting complexities involved in pursuing sanctions in cases of this type. Where the matter involves lawyers at a large law firm, regulators face opponents with the resources and incentives to resist discipline vigorously. Consequently, regulators are reluctant to take action. (Geoffrey Hazard and Ted Schneyer, ‘Regulatory Controls on Large Law Firms: A Comparative Perspective’ (2002) 44 Arizona Law Review 593, 607…) This, in itself, undermines the effectiveness of the regulatory system and public confidence in the legal system generally.194
There is a heavy onus on the courts and on lawyers’ disciplinary bodies to deal quickly, and very firmly, with misconduct, once it has been revealed. However, because misconduct is not easily uncovered, lawyers, too, bear a significant responsibility to ensure the creation of an ethical culture within their firms. That is an aspect of the duty owed by them to the court, which tends to be expressed in such a way as to emphasise the public interest in preserving confidence in the administration of justice: Oceanic Life Ltd v HIH Casualty and General Insurance Ltd.195
The notion that lawyers are officers of the court is not empty rhetoric. Eugene R Gaetke, an American academic, said:
Lawyers like to refer to themselves as officers of the court. Careful analysis of the role of the lawyer within the adversarial legal system reveals the characterization to be vacuous and unduly self-laudatory. It confuses and misleads the public. The profession, therefore, should either stop using the officer of the court characterization or give meaning to it.196
In Western Australia, lawyers do not have the option of ceasing to use the characterization. It is imposed by statute.197 They are consequently obliged to give meaning to it.
VI Conclusion
Experience has demonstrated that, although legislative responses are necessary, and codes of conduct or ethical guidelines are helpful, they are not enough. It is impossible to legislate, or even to prepare a code of conduct, so as to meet every eventuality. Nor, for reasons already discussed, is it desirable to encourage, or even facilitate, a mindset whereby people obtain moral guidance in corporate decision making
194 Harvey and Le Mire, above n 54, 177-178. 195 [1999] NSWC 292 [48] (Austin J). 196 Quoted by Nader and Smith, No Contest (1996) xxi. 197 Legal Profession Act 2008 (WA) s 29.
168 JAMES HARDIE, NAB AND AWB LTD - WHAT HAVE WE LEARNED? by referring only to the letter of the law, or to a code of conduct, or both.
Nor is it enough to rely upon the presence of independent directors and upon strengthened powers, and duties, of audit, remuneration and nomination committees staffed primarily by independent directors (although these are essential in the case of listed companies). Companies must ensure that only men and women with a strong moral compass are appointed to the board and, importantly that they include at least some who have expertise that will enable them to have a sound understanding of the business of the corporation and of its financial affairs. It is also important that the ‘independent’ directors be truly independent, and persons of sufficient strength to withstand pressure from the CEO. At the end of the day, this is the responsibility of the shareholders. It is one that must be taken seriously by them.
There must also be an atmosphere that encourages and rewards ethical behaviour and that encourages the reporting of, and disciplines unethical behaviour. There should be a strong focus on risk management and attention to the structure of remuneration packages. Carolyn Cordery draws the following conclusions from her analysis of the NAB foreign exchange scandal:
The ASX corporate governance guidelines encourage boards to recognise and disclose risk so that it is managed appropriately. This requires ethical and responsible decision-making. If market confidence is to be served by such governance guidelines, it is imperative that corporate governors provide remuneration systems, internal controls and discretionary decision-making structures that reward ethical behaviour. Appropriate remuneration systems should reward profits, but be offset by an acknowledgement of the risk of unrealised positions. Other internal controls should include hiring and orientation procedures that reflect the organisation’s ethical culture. Supervision and security restrictions must provide clear guidelines on discretionary decisions and facilitate reporting by dealers and their supervisors of risky positions, especially negative news.198
It is important, also, not to lose sight of the fact that, although s 181(1) of the Corporations Act 2001 (Cth) requires directors and officers of a corporation to exercise their powers and discharge their duties in the best interests of the corporation (a formulation that does not encompass only the interests of shareholders),199 that does not mean
198 Cordery, above n 12, 67. 199 See, for example, The Bell Group Ltd v Westpac Banking Corporation (No 9) (2008) 70 ACSR 1, [4384]-[4450] (in an insolvency context, although not owing an independent duty to creditors, directors are obliged to take into account their interests) and the discussion in Austin, Ramsay and Ford, above n 143, [8.100]- [8.130].
169 (2010) 12 UNDALR that directors may not take other interests into account, at least if this can be done consistently with the best interests of the corporation. The authors of Ford’s Principles of Corporations Law200 suggests that the management of a company may be justifiably concerned to ensure that the company is a good corporate citizen. Institutional investors (who own around 45 per cent of the capital of listed Australian companies)201 can, and sometimes do, play a role in this respect, by investing only in companies that have a demonstrated record of good citizenship. Moreover, there is much to be said in favour of David Walker’s suggestion (made in his July 2009 ‘Review of Corporate Governance in UK Banks and Other Financial Entities’,202 commissioned by the UK Prime Minister) that institutional shareholders should exercise their voting powers and disclose their policies on voting and their voting record on their websites, or in some other public forum.
Finally, lawyers and accountants have to play their part. Both professions must be scrupulous in demanding, and enforcing, compliance with standards of professional ethics and responsibilities.
As George Bernard Shaw once said, the only thing we really learn from history is that we never learn from history. This may often be because it does not suit us to learn from history. But if we want to live in a society that respects individual rights, and that avoids catastrophic failures of the kind that have occurred from time to time in recent history, we have to learn from it.
This requires society, in all of its emanations, to condemn unethical corporate behaviour, and also extremes of greed of a kind that is so common (particularly when it comes to rates of remuneration of corporate executives) as to be now almost respectable. It requires shareholders to be vigilant and to have no hesitation in getting rid of directors who behave unethically, whether through greed or otherwise. It requires directors to remind themselves of their wider responsibilities as members of a civil society, and to act accordingly. It requires accountants to be true to the ethical rules that they claim to espouse. It requires lawyers not to lose sight of the overriding duties that they owe to the administration of justice.
200 Austin, Ramsay and Ford, above n 143, [8.130]. 201 Austin, Ramsay and Ford, above n 143, [7.630], quoting G Stapledon, ‘Australian Share Market Ownership’ in G Walker, B Fisse and I Ramsay (eds), Securities Regulation in Australia and New Zealand (1998) 245. 202 Quoted by Austin, Ramsay and Ford, above n 143, [7.700].
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