Important new Melbourne Law School study sheds light on the application of penalties for company directors

    Jasper Hedges, Research Fellow at the Melbourne Law School of the University of Melbourne

    New research from the Melbourne Law School questions whether statutory agencies are sufficiently applying policies that enforce directors’ duties and deter corporate misconduct.

    The findings suggest that the Australian Securities and Investments Commission (ASIC) and Commonwealth Director of Public Prosecutions (CDPP) are not applying enforcement policies around directors’ duties, to a large extent, in practice.

    Where director liability is proven, criminal over civil enforcement is favoured and agencies rely on incapacitative sanctions, such as a custodial sentence with a minimum period, civil disqualification orders or administrative disqualifications.

    This pattern of penalties is at odds with a pyramidal model of enforcement, which requires that more lenient enforcement measures are considered before harsher penalties.

    “The evidence suggests that the current enforcement of directors’ duties by statutory agencies might be not be sufficient to deter director misconduct,” says Jasper Hedges, Research Fellow at the Melbourne Law School of the University of Melbourne, and lead author of ‘The Policy and Practice of Enforcement of Directors’ Duties by Statutory Agencies in Australia: An Empirical Analysis’.

    The paper, co-authored by Helen Bird, a Research Fellow, Dr George Gilligan, Associate Professor Andrew Godwin and Professor Ian Ramsay, has been published in the Melbourne University Law Review. The research is part of the ASIC Penalties Project, funded by the Centre for International Finance and Regulation, and the University of Melbourne.

    The research is the most comprehensive of its kind in Australia. Previous studies typically relied on ASIC media releases for data. The Melbourne Law School team analysed each case individually and, through a Freedom of Information request to the CDPP, analysed lower court matters that are usually excluded from similar analyses.

    The result: a 10-year dataset (2005 to 2014) of 27 civil, 72 criminal and at least 199 administrative directors’ duties matters (involving 360 defendants) brought by ASIC and the CDPP.

    ‘Perceptions’ of being caught

    The study is timely. Ensuring there are sufficient sanctions to deter corporate misconduct – and that they are enforced – is central to maintaining Australia’s high governance standards.

    ASIC and the CDPP account for about half of all judicial matters involving directors’ duties and ASIC is responsible for a large number of administrative actions, such as director disqualifications. Public enforcement of directors’ duties has had a central role in Australia for years, far more so than in the United States and United Kingdom by comparison.

    The Commonwealth Government committed to reviewing ASIC’s enforcement and penalties regime in 2017 in response to recommendations by the Financial System Inquiry. Most recently, the Senate Economics References Committee led an inquiry into the “inconsistencies and inadequacies of current criminal, civil and administrative penalties for corporate and financial misconduct or white-collar crime” in 2015-16.

    The committee’s report, published in March 2017, made six recommendations. These included amending the Corporations Act 2001 to increase the current level of civil penalties for individuals and corporations; that civil penalties for white-collar offences are set at a multiple of the benefit gained or loss avoided; and ASIC be given disgorgement powers (to require the giving up of profits illegally obtained) in relation to non-criminal matters.

    These are sensible recommendations, although arguably too limited given the Melbourne Law School’s finding. If adopted, the recommendations would potentially increase penalties for director misconduct and give ASIC greater powers. But they do not address the key issue: how laws given to the statutory agencies on directors’ duties are being used.

    Academic research consistently shows the perceived probability of being caught is the biggest deterrent to criminal activity. The size of punishment is secondary. Melbourne Law School research found only 360 defendants in public directors’ duties matters over 10 years – tiny in the context of almost 2.5 million Australian companies.

    “There needs to be a perception among company directors that there is a real risk they will be caught for breaches of directors’ duties, that the penalties are significant and sufficiently applied,” says Hedges. “It is hard to conclude that is currently the case, based on our data.”

    Key findings

    The study found civil enforcement was significantly less prevalent than criminal enforcement on directors’ duties breaches (see table below). Civil enforcement accounted for just under a fifth of matters involving directors’ duties that attract both civil and criminal liability.

    Incapacitative sanctions were almost four-fifths of director sanctions. The relatively high use of disqualification orders for company directors over other penalties does not surprise; ASIC has powers to disqualify directors and it is a simpler process than going to court.

    Although less severe than criminal penalties, being disqualified from company directorship for up to five years can cause significant personal reputational damage for directors. Loss of reputation may be a more significant deterrent than small civil penalties.

    Table 5: Number of Sanctions Imposed for Contraventions of Directors' Duties

    Source: The Policy and Practice of Enforcement of Directors’ Duties by Statutory Agencies in Australia: An Empirical Analysis’. See paper for footnotes.

    Another issue is monetary sanctions and custodial sentences set well below the statutory maxima – a trend that “casts doubt on their deterrence value”, argue the authors. The median civil penalty imposed on defendants who engaged in a single contravention of directors’ duties was $25,000 (or 12.5 per cent of the maximum $200,000 per contravention).

    About 46 per cent of custodial sentences for contraventions of directors’ duties were fully suspended. Only 43 defendants received a custodial sentence with a minimum period of incarceration and the average minimum sentence for defendants was 8.86 months.

    Table 6: Magnitude of Monetary Sanctions Imposed for Contraventions of Directors' Duties

    Source: The Policy and Practice of Enforcement of Directors’ Duties by Statutory Agencies in Australia: An Empirical Analysis’. See paper for footnotes.

    The evidence suggests that few directors serve jail time in Australia for breaches of directors’ duties and, when they do, the minimum sentence on average is less than a year.

    “On average, 14.2 defendants per year were found liable in court proceedings for breaches of directors' duties over 10 years,” says Hedges. “It is fair to raise concerns about whether the rate of enforcement is too low given the large number of companies in Australia, and if penalties are sufficient. The penalties on paper sometimes look more severe than they are in practice.”

    The research also found low enforcement around certain directors’ duties: related-party transactions, misusing information and insolvent trading, for example. “The small number of cases involving insolvent trading was particularly surprising, given insolvency firms are required to report to ASIC any suspicions of director misconduct,” says Hedges.

    He says the prevalence of criminal over civil penalties is an interesting finding. Some qualification is needed because civil matters can involve high-profile cases with multiple defendants, meaning less discrepancy in the two forms of penalties (on a defendants basis). But the evidence suggests statutory agencies tend towards more severe penalties.

    “There is obvious logic in trying to apply the harshest penalties to high-profile cases, to send a message to the business community,” says Hedges. “But the theory of responsive regulation is that you try less severe methods first, such as education, advice and community engagement, then financial penalties, and at the peak, director disqualification and criminal penalties. In Australia, we tend to go for the most severe penalties first for directors.”

    Areas for consideration

    Hedges says the research suggests several areas that requiring strengthening.

    The maximum $200,000 civil penalty for a single contravention, set in 1993 and not adjusted for inflation, should be lifted. “The level of financial penalties is strikingly low,” says Hedges. “Civil penalties often apply to directors of very large corporations and sophisticated groups; even the maximum size of the penalty can be insignificant to some.”

    He believes the maximum civil pecuniary penalty for breaches of directors’ duties should be lifted from $200,000 to $500,000, which is equivalent to the penalty for individuals contravening the cartel conduct provisions and other restrictive trade practices under the Competition and Consumer Act 2010 (Cth), and the maximum criminal fine should be equivalent to insider trading and other market misconduct (2000 penalty units to 4,500).

    ASIC’s maximum disqualification order for directors ought to be increased to 10 years, from five years now, argues Hedges. Tougher penalties are also needed for disqualified company directors who breach the order (the maximum fine now is $9,000 or one year in prison).

    “There is inconsistency in disqualification orders,” says Hedges. “A disqualified director who serves as a director for another company might receive a $9,000 fine or one much lower. Rarely will they serve jail time for a breach. It raises questions about whether there is sufficient incentive for directors to abide by disqualification orders.”

    Hedges says ASIC could make better use of media to strengthen community perceptions about white-collar crime being detected and punished. The research found ASIC media releases covered only about half of administrative director disqualification orders, even though incapacitative sanctions are by far the main penalty used in directors’ duties breaches.

    “ASIC is missing an opportunity to promote enforcement actions and use them as a deterrent for white-collar crime,” he says. “Greater use of social media, advertising, public warnings and other marketing channels could get the message out and act as a deterrent.”

    Hedges says Australia has some of the strictest laws around directors’ duties and is well regarded internationally for its work in this area. “The issue is not whether we have the right laws, but whether they are sufficiently enforced and, if not, why?”

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