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Financial reporting failures, board's competency and effectiveness

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Abstract

Financial misreporting and accounting misstatements figure prominently in recent corporate scandals. Although the more notorious of these involved directors’ fraud and conflict of interests, there are cases that are indicative of a board that has failed to exercise its oversight duty where directors were negligent, resulting in loss or damages to the company. This article highlights the following governance issues: the relevance of financial literacy or expertise and its enforceability and process, and procedures that could improve board's effectiveness. As the cases involving financial reporting failures publicly unfold in courtrooms and in the media, boards and regulators need to rethink and reconsider the suitability of current board practices and regulatory response to governance breakdowns. This article places the discussion within the context of several case studies that deal with specific instances of financial reporting failure and are of interest because of the involvement of and liability risks for non-executive directors. This article is also interesting from a comparative law perspective in view of increasing the number of companies undertaking cross-listing or dual listing of shares. A more consistent approach among the regulators is needed to prevent regulatory arbitrage.

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Notes

  1. Some countries such as Australia and the United States require the accounts to be signed off by the person primarily in charge of the financial affairs of the company, that is, the chief financial officer or the chief executive officer who may or may not be a member of the board.

  2. See Paragraph 15.09 of the Bursa Securities Main Market Listing Requirement: (a)must be a member of the Malaysian Institute of Accountants; (b)if he is not a member of the Malaysian Institute of Accountants, he must have at least 3 years of working experience and – (i) he must have passed the examinations specified in Part I of the First Schedule of the Accountants Act 1967; or (ii) he must be a member of one of the associations of accountants specified in Part II of the First Schedule of the Accountants Act 1967; or (c)fulfils such other requirements as prescribed or approved by the Exchange. See also Practice Note 13, Paragraph 7.1 of the Bursa Securities Main Market Listing Requirement where for the purpose of complying with the composition of the audit committee, the following qualification will also be accepted:  (a)that the audit committee member fulfills either one of the following qualifications and at least 3 years of post-qualification experience in accounting or finance: (i) a degree/masters/doctorate in accounting or finance; or (ii)a member of any professional accountancy organization, which has been admitted as a full member of the International Federation of Accountants; or  (b)the audit committee member has at least 7 years of experience being a chief financial officer of a corporation or having the function of being primarily responsible for the management of the financial affairs of a corporation.

  3. Financial experts can be further categorised into three types: accounting financial experts (for example, CPAs and CFOs), supervisory financial experts (for example, CEOs, board chairs) and user financial experts (for example, financial analysts, investment bankers); see Hoitash et al (2009).

  4. This line of argument was also considered and rejected in the United Kingdom's decisions involving prospectus misstatements, somewhat similar to some recent cases involving financial misreporting in prospectus and other capital raising documents. The article cited Tait v Macleay [1904] 2 Chapter 631 (reliance on assurance received from issuer’s solicitor that all contracts required to be disclosed did not provide defence to Companies Act 1867s 38); Watts v Bucknall [1903] 1 Chapter 766 (director cannot avoid liability under Companies Act 1867s 38 by hiding behind legal opinion that no disclosure is required); Twycross v Grant (1877) 2 CPD 469 (view formed in good faith that no disclosure is required is not a defence under Companies Act 1867s 38).

  5. The trial decision was appealed and heard in Morley v ASIC (2010) NSWCA 331, the finding of directors’ liability was overturned because of the lack of evidence as to whether the announcement was approved at the board meeting or modified without the board's knowledge or approval. However, for this factual finding, the directors would have been held liable because the appellate court was also of the view that this was not a situation where the directors should be allowed to rely on the expert report relating to the actuarial calculations. However, ASIC appealed against this decision. In ASIC v Hellicar and Ors [2012] HCA 17, the High Court of Australia affirms the decision of the trial court. The High Court found that the Court of Appeal was wrong to conclude that ASIC did not prove that the draft ASX announcement in question was tabled and approved at the board meeting.

  6. See R. v Moses HC AKCRI 2009-004-1388 [8 July 2011], Paragraph 81, citing in fn 103 the case of Papee v Fahey (2005) 9 NZCLC 263, 813(HC) where Ellen France J accepted that 138 could inform steps taken by directors in the context of obligations imposed by the Securities Act 1978.

  7. Three of Bridgecorp former directors have been found guilty for actual dishonesty in misleading investors in relation to Bridgecorp prospectuses and offer documents, as well as for knowingly making false statements in offer documents that Bridgecorp had never missed interest payments or repayments of principal to investors: R v Petricevic, Roest & Steigrad [2012] NZHC 665. Two directors, Davidson and Urwin, had entered a plea of guilty in relation to the criminal proceedings.

  8. See www.hedgeweek.com/2011/09/12/130684/corporate-governance-and-weavering-judgment. Despite the decision by the court, the Serious Fraud Office of the United Kingdom has announced that it was not proceeding with the investigation and not prosecuting Magnus Peterson, the former CEO. However, the liquidator has indicated the intent to bring a civil fraud case against several persons including directors owing to financial misreporting: see ‘Serious Fraud Office criticised for closing Weavering Capital investigation (Thursday 22 March 2012)’ www.telegraph.co.uk/finance/financial-crime/8750929/Serious-Fraud-Office-criticised-for-closing-Weavering-Capital-investigation.html (accessed 21 March 2012). Subsequently, in the UK proceedings brought by the liquidator in Weavering Macro Fixed Income Fund Ltd (In Liquidation) versus Peterson & Ors [2012] EWHC 1480 (Ch), directors were held to have acted negligently.

  9. See also the Singapore Code on Corporate Governance proposed revision 2011, Paragraph 4.6 and 4.7.

  10. According to the New Zealand Financial Markets Authority, two directors of the failed Five Star group – Marcus MacDonald and Nicholas Kirk – were the first finance company directors to be jailed. In New Zealand, for example, since 2006 and up to 2011, the Financial Markets Authority (formerly the Securities Commission) has charged 11 companies with civil and criminal proceedings filed against the directors of failed finance companies for, among others, causing the company to breach its reporting and disclosure obligations. There are continuing investigations involving 17 failed finance companies.

  11. The New Zealand Securities Commission (now the Financial Markets Authority) alleged that Nuplex Industries Limited has breached its continuous disclosure obligation under the Listing rules of the New Zealand Stock Exchange and the Securities Market Act 1988 by failing to disclose to the market a breach of a banking covenant. This case was settled in 2011.

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  1. Faculty of Law (Ahmad Ibrahim Kulliyyah of Laws), International Islamic University Malaysia, Jln Gombak, 53100, Kuala Lumpur, Malaysia

    Aiman Nariman Mohd-Sulaiman

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Mohd-Sulaiman, A. Financial reporting failures, board's competency and effectiveness. Int J Discl Gov 10, 155–174 (2013). https://doi.org/10.1057/jdg.2013.5

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