Law reporter: penalties for white collar crime

Professor Bob Baxt provides an overview of recent court decisions affecting the role and responsibility of directors.

Penalties for white collar crime – is too much power being given to the regulators?

Some weeks ago the community expressed concern at the implications of the Steve Vizard affair. In particular, regrets were raised that the Australian Securities & Investments Commission (ASIC) had not been able to bring criminal proceedings against Vizard for alleged breaches of the insider trading laws and other alleged breaches of the law.

Readers will no doubt recall that although the matter was referred to the Director of Public Prosecutions (DPP), the DPP felt that it did not have sufficient evidence to warrant a continuation of criminal proceedings. Whilst a great deal of publicity has been given to these matters, it is only now that we have had an opportunity to review the judgement of Justice Finkelstein in this case. This is discussed further below.

As it often occurs where there are prosecutions of persons for breaches of the Corporations Act (the Act), and for other important pieces of commercial legislation such as the Trade Practices Act (TPA), the relevant regulator – whether it is ASIC or the Australian Competition and Consumer Commission (ACCC), and in the future probably on a more regular basis, the Australian Prudential Regulatory Authority (APRA) – will strike ‘deals’ with accused directors or officers on the various breaches of the law and the penalty that should be imposed by the court with respect to the breach.

There has been some ‘resistance’ to these so-called ‘deals’ being struck by various judges. These deals were generally conducted without the direct involvement of the court. Some judges did not want to concede too eagerly to penalty orders struck by the regulator and the relevant defendant, and some judges have described the ‘penalties’ imposed as too low.

In particular, these have been cases involving breaches of the TPA in which this reluctance has been expressed by various judges from time to time.

In the Vizard case, which has now been reported in the Butterworths Company Law Reports (Australian Securities & Investments Commission v Vizard (2005) 54 ACSR 394), Justice Finkelstein, who had previously been outspoken at the apparent failure of ASIC to bring criminal proceedings in such matters, and who has also been ‘crusading’ for tougher criminal sanctions for what he has described as ‘white collar cases’, conceded that there was authority to the effect that the court should not depart from the penalty recommended by the parties.

The judge, however, indicated that the penalty “struck” was arguably on the low side. He also conceded that if he had not been provided with the relevant authority or submissions as agreed to between the parties:

“I would have imposed a higher penalty, but not substantially different from that suggested…If this penalty is insufficient, Parliament should increase the maximum. The current amount has been in place for more than 13 years and may require review” (at para 45).

Justice Finkelstein took the opportunity to make it clear that he regarded insider trading as a matter that should receive a more focussed and intense attention from our lawmakers. It is useful to review his comments, which – as indicated – have now been reported.

He was particularly critical of the treatment of what is generally known as ‘white collar’ crime. In his view, traditional sentencing regimes have been able to discount the level of penalty imposed on ‘high profile’ persons for breaches of ‘white collar’ laws, by virtue of the fact that any kind of penalty would significantly impact on the relevant persons’ “unblemished past life, a reputation for honesty, an involvement in and a contribution towards community affairs…” (at para 36).

Justice Finkelstein felt that the law should place a limit on how far the good reputation and past performances of the accused should limit or minimise the penalties that might otherwise be imposed. In his view:

“…corporate crimes committed by prominent business people have a tendency to erode the moral base of the law and provide an opportunity for other offenders to justify their misconduct. At a more immediate level corporate crime is diffuse in its impact, is easily concealed with seemingly legitimate business transactions and is difficult to detect, control and punish. Corporate crimes are usually committed to accumulate wealth and power and are almost always the result of deliberate and calculated conduct” (at para 37).

His rather reluctant concession to the fact that the regulator has the power to negotiate an appropriate penalty may become more significant for relevant parties evaluating how hard they might wish to defend a particular case. It may impact on whether parties will seek to “do a deal” or fight the case on its merits. Jail sentences are likely to become more relevant (and the ACCC has certainly indicated that it wishes to emphasise the potential of jail terms in relation to cartel conduct).

In this climate, I suspect that there may be more significant “objections”, delays and detailed litigation in the future. Not all of the directors involved in the failure of One.Tel have agreed to negotiate claims made by ASIC against them (although two directors of One.Tel have done so).

There are still many cases proceeding through the courts. Indeed, in the same volume of the Butterworths Corporate Law Reports in which the Vizard case was reported, the New South Wales Court of Appeal is reported as refusing to interfere with certain pre-trial orders made by Justice Austin in relation to documents that were obtained by ASIC and which it was seeking to introduce into evidence against One.Tel’s Rich and other directors.

In Rich & Anor v Australian Securities & Investments Commission ([2005] 54 ACSR 365), the New South Wales Court of Appeal indicated that it would be rare for the court to grant leave to review interlocutory rulings of the trial judge in matters relating to practice and procedure, including rulings on the evidence to be omitted. The court felt that it was not appropriate to do so, because this would lead to a fragmentation of the trial and thus further delay the pursuit of the regulator’s case and important matters of public interest.

As noted earlier, we have not yet seen the end of the litigation involving the One.Tel company, nor indeed one or two other ‘failed’ companies in which actions are being brought by ASIC and by other regulators. The willingness (although reluctant) of the court to concede more and more power to the regulator as long as certain steps are taken in negotiations with the appropriate regulator, suggests that we will see the reduction in a number of full-blown trials in high profile cases with more and more of these matters being dealt with in an administrative fashion.

The court will be used more and more often to ‘approve’ (even if the courts will not concede that they are rubber stamping the process) the arrangements entered into between the regulator and the relevant directors being charged with breaches of the law.

Challenges to directors’ salaries – how the pressure may build

In two recent separate sets of developments, we have witnessed increased attention being paid to questions concerning remuneration and salaries of directors of companies.

Of course, in the context of public companies, the issue was brought to a head with the passage of the CLERP 9 legislation in 2004. Under this law, shareholders are now able to vote, in a non-binding fashion, at annual general meetings on the remuneration being paid to directors of public companies.

In a recent article in The Australian Financial Review (Wednesday 2 November 2005), it was reported that in meetings of at least 25 per cent of major Australian listed companies, ‘protest votes’ had been made against the pay policies of the boards of those companies.

The Australian Financial Review story suggested that in 17 of the 68 companies that had so far placed their Remuneration Report to relevant annual general meetings, the votes of ten per cent or more of the members had been to oppose the relevant remuneration being paid. The reporters, Fiona Buffini and Ian Howarth, suggested this figure increased to almost a third of the relevant companies if abstentions from voting were counted as votes against the board. The Australian Securities & Investments Commission (ASIC) is reported to be “reviewing” some of these companies.

There is little doubt that there will always be the potential for protest votes at meetings of companies in relation to questions concerning the running of the company. The growth of outspoken minority groups and the increased attention paid by the media to the performance of companies will enhance this trend.

Whether this trend, as outlined in The Australian Financial Review story, is an indication of things to come is perhaps more dubious. What is clear, however, is that more attention will be paid in the next 12 to 24 months, in particular, to this question of remuneration for directors – not only of public companies, but proprietary or private companies in appropriate circumstances – as has recently been shown by an interesting case in the New South Wales Supreme Court.

The chief justice in Equity of the New South Wales Supreme Court, Justice Peter Young, has recently made interesting observations and orders in relation to a dispute in a small private company in which a shareholder protested against the remuneration being paid to the relevant directors. This arose at the time there was a change of control in the relevant company.

In Herbert v Herbert ([2005] NSWSC 1034), the action was, by way of an interlocutory application (that is not based on a full consideration of the merits, but seeking urgent orders to retain the status quo of the relevant company pending a consideration of the matter in greater detail). The critical issue as argued by the plaintiff was to “preserve the assets of the company” prior to the hearing of the more substantive action. The major allegation was that the company South Coast Truck Sales & Spares Pty Ltd had had its affairs conducted oppressively by the controlling directors. The company had been incorporated in 1976 and had been quite successful.

As is not uncommon with small proprietary companies, management shares had been issued to the persons responsible for running the company (such management shares usually carry with them the right to receive certain additional benefits that perhaps do not accrue to other shareholders). Barry James Herbert, the person who had control of the company (with his late wife) had died in 2004. The surviving children were in dispute as to whether those who were running the company were receiving appropriate rewards or remuneration or whether this was an excess of what should be allowed.

The plaintiff alleged that the company was not being run fairly by the sister of the plaintiff – a Gail Herbert – who was the beneficiary of 50 per cent of the shares held by the late Barry Herbert, and by another director. The plaintiff had apparently made it clear to her sister, Gail Herbert, that she was not happy with the fact that no dividends had ever been paid by the company, that Gail Herbert was apparently receiving remuneration of $4,000 per week, and that there were arguments as to the repayment of debts owed by the company. These proceedings had been issued to urgently clarify these matters.

Because the company was a proprietary company, it was not required by the relevant legislation to have its annual accounts audited. Justice Young did not believe that he had a general discretion to order that the previous years’ accounts should be audited – despite the allegation. This would add a considerable cost to the company.

However, he had little doubt that the plaintiff, as a substantial shareholder in the company, had the right to demand certain information – in particular, that she and others should receive a financial report and directors reports for the relevant financial years. The preliminary evidence presented to the judge suggested that there was a reluctance on the part of the directors:

“…to come forward with [relevant information], [there were] discrepancies in figures in the material that had been presented [to the court], [there was apparent] non-compliance with the requirements of the [Corporations Act] as to the formulation of the [relevant] defendant’s remuneration and there was evidence of the non-holding of general meetings” (at para 23).

All of these matters pointed to the: “…need for an independent auditor or some consulting accountant to provide a proper audit and report to the members as to what those in control of the company had been doing and how accountable they should be for the profits of the company” (see para 23).

However, the judge was not prepared to go back in time beyond the financial years ending 30 June 2004 and 2005.

As noted earlier, there is likely to be a more detailed hearing in relation to the allegations of oppression. The plaintiff in the interim asked that the court order that the relevant directors not receive any payment pending the hearing.

However, the articles of this company provided that the members in general meetings could determine the remuneration of the directors. There had been no such resolution passed by the relevant company.

Indeed, what appeared to have happened in this case was that:“…there was a meeting between the first defendant [and another member of the family] and they agreed on the remuneration. That would not, to my mind, seem to be sufficient for a number of reasons. First, it gave the plaintiff [who was a shareholder] no opportunity to object. Secondly, the first defendant was interested in the contract and thirdly, there was no meeting at which the pros and cons could have been debated” (at para 28).

In the circumstances, the judge ordered that the ‘agreed’ figure of $4,000 per week should not be paid to the first defendant pending the hearing of the matter.

Justice Young, however, was not prepared to accede to the claim that there should be a review made of what had already been paid to the defendant (she was receiving approximately $208,000 a year). He felt that he did not have sufficient information to make such an order. This was an issue that might be dealt with by the court at the full hearing of the case.

The judge then went to consider whether he should place the company under provisional liquidation. Whilst he felt that this was a case where a provisional liquidator should arguably be appointed, it was not something that he was prepared to do at this time.

As indicated earlier, this was a case involving a small proprietary company and readers should not get too carried away by decisions of this nature.

What it does reveal, however, is that there is likely to be a greater interest in these matters today, and that for some considerable period of time more companies will be placed ‘under the microscope’ not only by shareholders at general meetings, and by the media in the case of high profile companies, but also in appropriate proceedings by the courts.