Green’s Piece: Own goal scored in Centro case

John M Green argues that the Centro case may be bad for good directors.

Soccer fans have been whooping it up since the celebrated midfielder Harry Kewell returned to our shores. Meanwhile, the court in the Centro case kicked an own goal by importing the worst from Europe, not the best. It prompted me to pen this limerick:

Back is the Marquess of Bute/ who saw his board seat as moot./ Instead of attending,/ he focused on spending/ his time at his club, with a cheroot.

In 1886, the Cardiff Savings Bank went bust, and while the Marquess had held his directorship for almost 40 years, he attended one board meeting. Even so, his Lordship hadn’t breached his director’s duties because the court said he was entitled to rely on those directors who did take part.

Until the Centro case, Australian corporate governance experts happily thought this approach had been long buried, but perhaps no longer.

In an earlier column (Company Director, September 2011), I argued that the first Centro decision — finding the then board had breached its collective duty in approving the accounts — was bad for shareholders and bad for our economy. The court’s subsequent decision on penalties is even worse and perversely, may have the effect of cosseting the careless director rather than encouraging the diligent one. Because of this decision, good directors may now be at risk of bad ones.

I come to this view despite having no quibble with the court’s finding that approving and signing a company’s annual accounts is a collective board decision.

I also arrive at this view believing the so called "slap on the wrist" penalties awarded against Centro’s then non-executive directors (NEDs) were hardly remarkable, despite the public uproar.

Once the judge decided the NEDs’ conduct was "undertaken honestly and by intelligent, experienced and conscientious people" and that while "their conduct fell short of what was required, they are not people from whom the public must be protected in the future", why would he penalise them further?

My concern arises simply because, in coming to his penalties decision, the judge expressly declined to consider each NED’s individual behaviour.

Instead, he bound them all together as Siamese sextuplets, saying: "In this proceeding, the Australian Securities and Investments Commission focused on treating the [NEDs} as all having the same care and responsibility… [T]he proceeding was in essence one involving the board as a whole having the same responsibility with respect to the financial statements… In these circumstances, I do not differentiate between the [NEDs] in considering the appropriate penalties."

With respect, this approach is seriously and dangerously flawed. Though directors may reach a collective decision, they will come to it in different ways.

In the Centro case, penalising them based on their individual efforts wouldn’t have made a difference since the court found all the NEDs were conscientious, even though the evidence suggested some were more meticulous than others.

But surely there will be cases in future where another board mistakenly signs off on its corporate accounts, but hidden among its number are a couple of Marquesses of Bute. If courts follow this new Siamese sextuplet approach, what will that mean for the "good" directors on that board? After all, can you ever really be certain that an amiable board colleague has actually read his or her papers?

Sadly, despite his two 180-page judgments, the Centro judge doesn’t reveal his thought process on this. But if you think about it, there can only be two judicial approaches in such a case, apart from the preferable one of surgically separating the sextuplets.

The first is to apply a "lowest common denominator" test, where a court will focus on the worst directors to see if they were conscientious enough. The other is a "holy water" test, where the court will focus on the best directors and sprinkle their standard of care over the heads of a board’s worst.

Both tests are bad for the good directors, and bad for their shareholders. Each has different but equally appalling consequences.

If the holy water test were to hold sway, it would breathe life back into the Marquess of Bute. The only care lazy directors would need to take is in surrounding themselves with diligent directors so they can happily collect their fees while contributing nothing.

The lowest common denominator test is also troubling. This one doesn’t protect the careless or the carefree; it’s worse because it harms the careful. If you are diligent, but unlucky enough to sit on a board where you discover too late that some of your co-directors are out to lunch, the court could drag you down to their level.

In sport, you win or lose as a team. But you also improve your team’s prospects by importing the best players, not by cosseting the worst.

According to the Centro judgment, corporate boards also win or lose as a team. But even so, it will hardly be wise to fine a good player for the incompetence or stupidity of a teammate.

John M Green FAICD is a leading company director, and author of the novels Nowhere Man and Born to Run.