Discuss about the Fiduciary Structure Of Investment Management Regulation.
The recent decision in ASIC v Flugge (No 2) [2017] VIC 117 given by the Supreme Court of Victoria is a sequel to the ASIC v Flugge and Geary [2016] VSC 779 that was decided in 2016. The Australian Securities and Investments Commission [ASIC] initiated a legal action against Mr. Flugge for contravening directorial duties under the Corporations Act 2001 (Cth). The contravening conduct of the defendant was alleged to have been resulting from AWB’s conduct in selling wheat to Iraq under the UN Oil-for-Food Program [OFFP]. The plaintiff has claimed penalty of $200,000 to be imposed upon the defendant for such contravention and disqualification of Mr. Flugge from managing corporations for a period of 10 years. Further, the plaintiff claimed that the defendant must pay seventy percent of the expenses incurred by the ASIC.
The defendant applied for pardoning the penalty and sought for a court order that ASIC pays for proceeding expenses. However, the court exercised its discretionary power and held that the plaintiff was not entitled to exonerated application under section [1318] or section [1718S] of the Act. Further, the contravention of the defendant is established which led to the imposition of pecuniary penalty of $50000 and disqualified the defendant for 5 years.
The plaintiff, Trevor Flugge who was the director and the chairperson of AWB Ltd had committed breach of section [180(1)] of the Corporations Act between 19 December 2001 and March 2002. The defendant failed to discharge his duties and exercise his powers with due care and intelligence, which any prudent person would exercise if such person was under similar circumstances and holding the same position carrying out the same responsibilities within the AWB Ltd as the defendant.
The defendant is said to have committed a breach of section [180(1)] of the Act as he failed to make any adequate inquiries about the approval of the UN regarding sale of wheat to the IGB Iraq by Australian Wheat Board [AWB]. The defendant was aware that UN was making inquiries about inappropriate payments of transportation fees to Iraq. AWB was making payments of inland transportation fees Iraqi Grain Board [IGB].
The ASIC initiated two legal cases against the defendant for breaching his directorial duties stipulated under section [180(1)] of the Act. Hargovan (2017) states that the defendant had full knowledge about the fraudulent and offensive nature of the payment that is made by AWB to the IGB as inland transportation fees. However, the plaintiff ASIC failed to establish the case initiated in 2016 due to which it initiated another legal action against the defendant in 2017. In this sequel case, Laby (2017) states that the defendant established that he had no knowledge about the payment being offensive and fraudulent. Nevertheless, in the case of 2017, the plaintiff alleged that even if the defendant did not have any knowledge of the payment being fraudulent nature, he had sufficient means of knowledge to inquire if the UN approved of such payment which he did not exercise. This amounts to a breach of his directorial duties to act with due care and diligence under the corporations Act, 2001 (cth).
The decision of the court in determining whether the defendant had committed a breach of the legal provision, the court found Mr. Flugge to be in contravention based on the following grounds. Firstly, a director is required to exercise every possible means of knowledge to ensure diligence and due care has been complied while undertaking any actions on behalf of the company. In the case of [2017], the court found that the defendant was fully aware of the fact that the UN were making inquiries about the inappropriate payments being made by the AWB to IGB for trucking/discharge.
Secondly, the court held that any reasonable director under similar circumstances and carrying out similar responsibilities as the defendant would have exercised reasonable skill and cares to use the means to obtain information about the inquiries being made by the UN regarding the inappropriate payments made to Iraq.
Further, the court found that the defendant failed to establish that he undertook reasonable inquiries about confirming whether the payments made to Iraq were inappropriate. The defendant contended in his defense that he made the payments with the belief that the UN had approved of such payments. The court was not satisfied with this contention and rejected the same. However, Stewart (2017) agrees with the findings of the court as if the UN had approved of payment inland transportation fees, if would not have suggested such payments to be fraudulent and irregular in nature and neither it would have initiated any inquiries regarding such payment. Thus, given the information that the defendant already possessed about payments being offensive and fraudulent in nature, it is likely that the director breached section [180(1)] of the Corporations Act 2001 (Cth).
The defendant applied for an application for exoneration and relied on the decision of ASIC v Plymin (No 2) [2003] VSC 230 where it was held that court is empowered to grant exoneration with respect to any orders including a declaration of a contravention as stipulated under section 1317E of the Act. However, the plaintiff had rightly contended that under section 1317E, once a liability has been established, the court must make necessary declaration and ASIC relied on the decision of ASIC V Whitlam (No 2) [2002] NSWSC 591.
As stipulated under section [1317 S] and section [1318], three conditions must be fulfilled to determine whether the applicant must be granted relief. Firstly, the court must determine whether the applicant has acted honestly. Secondly, whether it would be fair to excuse the applicant and lastly, whether the applicant must be relieved from liability either wholly or partly.
Coffee, Sale and Henderson (2015) believes that the court has rightly determined that the defendant had not acted dishonestly as required under section 1317S (2) and 1318(1) of the Act. This is because there is no evidence that the defendant has not acted with an objective to deceive or earn monetary gains. The court was further right about the fact that the conduct of the defendant was not deceitful or that it did not amount to deliberate impropriety. However, as was stated in ASIC v APCH [2014] FCA 1308 [39]-[41], the court was bound to take into account of all the three elements must be satisfied to determine whether the applicant is entitled to be granted relief.
Therefore, Laby (2017) states that the court was correct to state that though the defendant did not act dishonestly and neither had any intention to earn monetary gains deceitfully, but the breach of duty committed by the defendant was severe in nature and had adverse outcomes.
Although the plaintiff had claimed $100000 penalty to be imposed upon the defendant for contravening section 180(1) of the Act, the court had exercised its discretionary power and imposed a penalty amount of $50000. According to Laby (2017), a pecuniary penalty imposed upon the infringer purports to act as a personal deterrent against the repetition of similar conduct like that of Australian Securities Commission v John Phillip Donovan and Julia Gwendolin Donovan [1997] No Qg 3006. Stewart (2017) believes that the decision given in this case explains the significance of imposition of pecuniary penalty as a deterrent. It was held that if compliance of director with the appropriate standards of commercial conduct while managing the corporations is achieved through deterrents, then penalty imposed upon the person should not be more than what is necessary to achieve such deterrence.
Stewart (2017) states that in order to determine whether disqualifications under the Corporations Act, the most appropriate approach was established in Rich v ASIC [2004] 220 CLR 129. The court must ensure that while disqualifying a director from managing corporations, it should not only consider public protection as the only ground and must have regards to deterrence, reformation, retribution and mitigation as well, as objectives of disqualifying a director. However, Laby (2017) states that if the disqualification provision is deemed to be completely protective in nature, then the court must determine whether the defendant is at present or in future will be fit for operating corporations.
If the court deems that the defendant would be fit and proper to operate corporations in the future, it is important to determine the appropriate time that shall be deemed appropriate for such director to become fit and proper as per the court. such determination must be made while considering that despite misconduct, the director would be competent to operate corporations.
As per the decision given in the sequel case of 2017, the court held that the conduct of the defendant was contrary to the conduct that is expected from a director by any reasonable person. The breach committed cannot even be considered as an accidental or a minor breach of directorial duties that may be pardoned. The payment made by the AWB for as inland transportation costs to Iraq were irregular and of fraudulent nature. Further, the payment was made under circumstances and that particular area which made it more important for the AWB to be cautious and careful, given that wheat was being exported to Iraq under the OFFP which was further tailored based on the prevailing sanctions rules.
Further, the defendant failed to establish why the inquiries were not made to confirm whether such inland transportation expenses being paid by the AWB to IGB had approval of the UN. Furthermore, the defendant did not provide any justified explanations for not conducting such inquiries except for the fact that it did not have any knowledge that such payments were irregular and fraudulent and that they continued with the payment with the honest belief that the UN approved it.
The decision given in this case has upheld the obligation of a director to discharge its powers with due diligence and care to ensure best interest of the company. Under the Corporation Act 2001 (Cth), a director is legally obligated to exercise reasonable care and diligence while carrying out corporation activities. As per the facts of the above case, the failure of the director, Mr. Frugge to exercise his powers as a director to use reasonable means for obtaining information regarding the inquiries made by the UN with respect to the inland transportation expenses. ‘
The case is significant as it also explains the importance of disqualification and penalty principles that are usually claimed by the plaintiff to be imposed upon the defendant for the contravention committed by the defendant. Like it was observed in this case that the plaintiff, ASIC had claimed to impose $100000 upon the defendant and subject him to disqualification from managing corporations for minimum 10 years.
However, the court had imposed penalty of 50000 and disqualified the defendant for 50 years after his contravention has been established. The reduction in the penalty amount as well as in the number of years of disqualification is because while determining such penalty and disqualification, it must not exceed than what is necessary to achieve the very purpose of imposing of such penalty and disqualification orders. The purpose of such disqualification and imposition of penalty is to deter the defendant from committing further contraventions and to protect the public against such contravention.
The disqualification term and penalty amount imposed upon the defendant in this case is proportionate to the amount of contravention committed by the defendant. Hence, in order to avert any such penalty imposition and disqualifications, it is important that directors must comply with their directorial obligations, which would not only lead to business development but will also ensure good reputation of the business amongst its stakeholders as well as the shareholders.
References
ASIC v APCH [2014] FCA 1308 [39]-[41]
ASIC v Flugge (No 2) [2017] VIC 117
ASIC v Flugge and Geary [2016] VSC 779
ASIC v Plymin (No 2) [2003] VSC 230
ASIC V Whitlam (No 2) [2002] NSWSC 591.
Australian Securities Commission v John Phillip Donovan and Julia Gwendolin Donovan [1997] No Qg 3006.
Coffee Jr, J.C., Sale, H. and Henderson, M.T., 2015. Securities regulation: Cases and materials.
Corporations Act 2001 (Cth)
Hargovan, A., 2017. Corporate law: Foreign directors of Australian companies put on notice: No leniency for ignorance of duties. Governance Directions, 69(1), p.37.
Laby, A.B., 2017. The Fiduciary Structure of Investment Management Regulation.
Rich v ASIC [2004] 220 CLR 129
Stewart, S., 2017. Are you the next ACM board director?. Australian Midwifery News, 17(2), p.33.
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