Every recession yields a shakedown of responsibility: political, legal, economic and corporate. When things go wrong, fingers are pointed. We are now witnessing, in addition to political finger-pointing, a great deal of buck-passing and blame-shifting in the corporate world. Inevitably some of this has ended in the courts.
Last week in the NSW Supreme Court Justice Rogers set out some principles dividing responsibility for huge corporate losses among auditors, senior management and directors. While he was dividing responsibility, there were others dividing blame. Justice Rogers was ruling on who should bear the alleged loss of $50 million by the Australian electronics company AWA Ltd, much of it in foreign-exchange dealing.
Under Australia’s corporate law, the foundation of which goes back 1{ centuries, responsibility and power is divided. Unlike a sole traders, who are themselves responsible for raising capital, making decisions about how it will be spent and the distribution of profit, companies split the responsibility for these functions. One of the central reasons for the law creating corporations was to create a dichotomy between capital and management. The corporation has been part of the genius of Anglo-Saxon capitalism. It has been a recognition that some people have capital, but no knowledge in how to put it to good effect, and others has skills of management, but no capital to put them to good effect. Married together, the results can be hugely productive. They are productive in a way not achievable without the legal creation of the business corporate entity, which has perpetual succession and can sue and be sued in its own right. The corporate entity has shareholders (who provide capital) and directors who provide management. Part of the genius of the corporate system is that shareholders have no inherent right to interfere with management. Collectively, they have a right to elect a board of directors, but after that they have no rights other than to vote to replace them. Even the distribution of profits is determined by directors. It is much like the relationship between voters and government in a democracy.
But this marriage of capital and management skills, like any marriage, is not without difficulty. An unscrupulous management might take unto themselves the profits of the company without the shareholders agreeing. They might also discharge their duties in such a negligent way as to cause the shareholders great loss. As the affairs of companies have become more complex, the principles of law guiding the responsibilities of directors and the rights of shareholders get more complex, the more so when driven by the financial losses of a recession and the desire on those sustaining losses to recoup from those they think responsible: and where better to recoup them than in the courts?
Thus Justice Rogers was faced with deciding who should bear the loss of $50 million lost on the foreign exchange market: the company, the shareholders, the directors, the senior managers or the auditors.
Auditors are another layer grafted on to the corporate law structure in a previous attempt to ensure that those who hand capital to managers by purchasing shares get more protection against negligence, folly and chicanery without forsaking the division of capital and management so necessary to effective and efficient production in a capitalist society. But the insistence on audit of companies has clearly not been a panacea. The answer this recession has given to the classic question who watches the watchers has been to sue auditors. Thus the auditing firm Deloitte, Haskins and Sells found itself in court. AWA itself brought the action against its auditors and former executives. By then the shareholders had tipped out the chairman and chief executive and the new executive, on behalf of their shareholders and using the company name, sought relief. Hence the importance of a company’s perpetual succession.
Justice Rogers found they were negligent in two AWA audits in 1986. he also found that AWA’s management failed to limit and control AWA’s former foreign exchange controller’s activities.
Significantly, Justice Rogers differentiated between executive directors and non-executive directors. The latter, attending a monthly board meeting were only responsible for setting broad policy directives. The bigger the company, the less detail they were responsible for. They were entitled to assume that the executive directors and senior managers of a company were putting into effect proper management procedures for day-to-day management. That seems a sensible division of responsibility.
None the less, Justice Rogers’s division of accountability will not be the end of the matter. No matter what controls (directors, executive directors, auditors or whatever) there can be no ultimate safeguard against incompetence or worse. In the end there will always be a competition among the innocent to determine who will bear the loss.
The lesson is that executive directors must ensure proper controls are in place throughout the company to ensure against excessive losses and that auditors must ensure the directors are informed of anything untoward in corporate finances or procedures. That said, it would be a shame if Justice Rogers’s judgment resulted in excessive caution. Risk is a fundamental element to capitalism and the benefits it has bestowed upon society. With risk comes loss. Not every loss is recoverable in the courts. Some of them are just plain luck or just plain bad judgment. In the case of the latter, it is often not a case of negligence. In which case the losses must lie where they fall. That’s business.