Professor Peter Swan

The bribery scandal and apparent cover-up revealed in yesterday’s ABC’s 7:30 Report and The Age that is now engulfing the Governor of the Reserve Bank of Australia (RBA), Glenn Stevens, his former deputy, Rick Battellino, now retired, and the RBA Board had its origins in one of Australia’s great technology success stories. This was the invention of plastic (polymer) bank notes in the 1980s. Having successfully protected its property rights despite fears of reverse engineering by overseas note printing interests, the RBA and two offshoots, Note Printing Australia (NPA) and Securency International, involved in polymer note printing and marketing, have been accused of covering up the scandal that involved payment of large bribes (secret commissions) to politicians and officials in a number of Asian countries.

When senior RBA officials were given a detailed memo providing details of the bribery scandal as early as 2007, the matter was not taken to the Australian Federal Police and there seems to have been no public acknowledgement of the problem until press reports raised the issue about two years later.

Although this is the second major bribery scandal involving exports to foreign governments, the kick-backs on the sale of wheat to Saddam Hussein of Iraq by the Australian Wheat Board being the first, this appears to be the first that has sparked a major police investigation and large-scale prosecution of officials involved. Corrupt payment of bribes is illegal in Australia, even to foreign officials and politicians, even though it is an accepted part of doing business in many parts of the world. In fact, many would regard it as a necessary cost of doing business and way to promote Australia’s exports.

As is usually the case, the bribery and corruption pales into insignificance relative to punishment metered out to those who cover-up. Richard Nixon was forced to resign, not for hiring the ‘plumbers’ in the first place but rather for his failed cover-up attempt.

The involvement of the most senior officials of the RBA and possibly the Board in the cover-up, even if they were unaware of large-scale bribery prior to 2007 in the bank-note offshoots, is an exceedingly damaging development for an organisation that until recently has retained a reputation for integrity and exceptionally good monetary policy in recent years.

Join the club!

There is an ongoing investigation into the Bank of England’s oversight of the rigging of the LIBOR interbank rate by Barclays and other British banks at a time when the Bank of England was facing the prospect of further massive public bailouts of the banks. Mr Bob Diamond, Barclay’s CEO who was forced to resign because of the scandal, explained to a senior Bank of England official at the time that “not all banks were providing [LIBOR] quotes at the level that represented real transactions.”

By this he meant that a number of banks including Barclays were deliberately understating their borrowing costs to make it appear they were more solvent than they really were. Lack of response from Bank of England officials, who claim not to have interpreted the conversation in this light, was taken by Barclays as implicit acknowledgement and support by the Bank of England for LIBOR rigging.

In the case of the US Federal Reserve, lax monetary policy and their success in bringing the cash rate down to close to 1% after the bursting of the internet bubble and 9/11 has been blamed for exacerbating the credit crisis that led to the GFC. Certainly, FED oversight over the lead-up to the GFC and the US NINJA loans scandal was weak. It has only recently been revealed that RBA and other Australian regulators were almost equally lax in allowing Australian banks and mortgage providers to push huge numbers of ‘low-doc’ loans on impecunious investors who had little or no prospect of repaying. Banks and mortgage providers seem to have secretly filled out forms to make it appear that borrowers were in a far more financially sound position than they were in reality.

The plastic banknote bribery scandal and cover-up places the largely very distinguished business people making up the RBA Board in an exceedingly difficult position. Did they know of, or should they have known what was going on at the time of the presumably secret 2007 Memo or even earlier?

In the CENTRO case, the court found that non-executive directors cannot uncritically accept advice from either management or auditors. Directors must take ultimate responsibility for company affairs. Of course, unlike CENTRO, the RBA is not a listed company with shareholders. It is the Federal Treasurer and Government that appoints directors to the RBA Board and thus should play an important role in its oversight. The Treasurer also appoints the Governor of the RBA. I should imagine that the Governor is accountable to the Treasurer, the Government, and perhaps ultimately to Parliament.

It is tragic that the scandal and apparent cover-up has damaged the reputation of the Governor, senior officials, board members and the RBA as a whole, despite the high regard for its conduct of monetary policy. The best we can hope for now is a quick end to the cover-up, if there really was one, and a speedy resolution of this very sordid affair. The successful setting of monetary policy is very much dependent on the reputation of the RBA. This needs to be repaired as quickly as possible.

Professor Peter Swan is the Professor of Finance at the Australian School of Business. This article first appeared in the Australian Financial Review.

Anil Hargovan

The Federal Court has not imposed extra penalties on six non-executive directors involved in the Centro court case, saying their convictions for breaching the Corporations Act are penalty enough.

My first impression suggests that Justice Middleton in the Centro case appears to have taken one step forward (in the liability decision which set the bar on directors performance standards in reading accounts dauntingly high) and two steps back (in the penalty decision handed down yesterday which did not go far enough in sanctioning oversight failure).

The tone of the penalty decision appears to be less caustic and more forgiving of the directors failure to exercise care and diligence.

The failure to throw the book at the directors in the penalty decision  has polarised the corporate community, attracted controversy and seen a vituperative reaction from sections of the media.

The penalty decision elevates shame and reputational loss as strong determinants of general deterrence but will not appease those baying for blood following significant oversight by the directors in the accounts involving billions of dollars.

The penalty decision boosts the directors shame and reputational loss as an effective deterrence tool.  Such sanctions will only be effective, however, for those directors who put a premium on their reputations.

Media reaction to the penalty decision would suggest that the penalties handed down were largely meaningless. It is important to remember that the judge refused to exonerate or grant forgiveness for breaches of the Corporation Act and did issue court declarations of breach of law which puts a stain of the cv of the directors and, more ominously, offers no comfort to the company and its directors facing class action by the shareholders.

In the refusal to grant forgiveness and the confirmation of breaches of law, the penalty decision has laid a stronger foundation and boosts the prospects of  shareholder success in the class action against the company. Herein lies the potential for a greater penalty afforded by this decision.  Perhaps the judge had one eye on the potential impact of the class action and tempered the penalty decision in light thereof.

Anil Hargovan is an Associate Professor at the Australian School of Taxation & Business Law at the ustralian School of Business.

Anil Hargovan

The need for directors to be aware of the business fundamentals, to have a questioning mind and to maintain familiarity with the financial status of the company is nothing new to the law on directors duties– such expectations were well established prior to the Centro decision.  However, when such expectations are marshalled and directed to the directors reporting obligations, they begin to bite.

It is now clear it is getting much harder to get people to sit on boards. This may be a hurdle for the government’s plan to increase the diversity of boards.

In September 2007 Centro directors failed to detect an error that led to more than $2 billion of short-term debt being classed as long-term debt. ASIC has now obtained a judgment that calls for proper diligence when directors are reading financial statements. 

I feel the message for directors is clear – namely, reading of the financial statements is not to be a passive exercise, nor will skim reading suffice.  Going through the motions will not be tolerated.  Scrutiny and the understanding of content is required.  This necessitates financial literacy skills. 

The need for financial literacy has been well established by case law. However I believe the Centro decision elevates the financial literacy requirement in a robust manner. 

On the facts of this case it was held that the apparent errors in the financial statements were not complicated.  This is a judgment call which potentially gives rise to uncertainty.

What may appear to be uncomplicated to a judge, with the benefit of expert evidence, may appear to be complicated to a director, particularly given the push towards board diversity by the ASX recommendations on good corporate governance practices.

We are entering unchartered territory here, especially not knowing to what extent should directors be familiar with accounting standards. The mapping of the boundaries, between complicated and uncomplicated items in financial statements, will be reliant on future case law in this area.  Until then, directors will have to live with this uncertainty which is unsettling and unsatisfactory.   

The sting in the judgment lies with the finding that being surrounded by financial experts, or having an Audit Committee, is helpful but not necessarily a panacea for the discharge of the directors reporting obligations.  The Centro decision sends out a strong message for directors to take their financial reporting obligations personally and seriously.  The approval of the company’s financial reports is a personal and fundamental responsibility of each director as emphasised by the judge which is a recurring theme in this case.

In the future the big issue from this decision is do we want to hand the responsibility to experts to free up the directors to focus on other matters like leadership in business skills and strategy or do we want to turn directors into accountants?

This is a policy debate raised squarely by the Centro decision which rejects the notion that compliance obligation for financial reporting lies exclusively with financial accountants.  Centro decision suggests that the time is ripe to revisit policy issues on the role of a company director to provide greater clarity and certainty on the demands expected of this profession.  Herein lies the danger – the Corporations Act says that anyone over the age of 18 can be appointed a director but then, with limited exceptions, remains largely silent on the performance expectations of directors. A reading of the Corporations Act gives little indication of the true challenges and skills set required to successful discharge the responsibilities of office of director. 

The Centro decision is also a wake up call for legislators to address and focus upon the current lack of direction and guidance in the Corporation Act, such as the need for financial literacy, which has simply failed to keep pace with judicial developments in this area of law.

In considering this, I also think there is a dramatic implications for boards in Australia. 

Company directors may be understandably concerned by the ramifications of the judgement which has the potential to undermine the movement towards more diversity of boards. The encouraging signs and momentum in attracting board diversity, currently at a record high, (Women comprised 25% of all new appointments to ASX 200 boards in 2010, compared to only 5% in 2009 and 8% in 2007 and 2008: AICD Figures) which may well be arrested as a consequence of the Centro decision.

Should the Prime Minister deliver on her threat to legislate to lift the representation of woman on boards, the policy outcome will be a potential disaster unless remediated/accompanied by lessons in financial literacy for all such appointees to the board.

Associate Professor Anil Hargovan is at the Australian School of Taxation & Business Law at the Australian School of Business