All directors should study the Centro judgment Centro property Source: AFP EVERY non-executive director in the country needs to sit down with John Middleton's judgment on the Centro Eight and carefully assess how the Federal Court judge's view of boardroom responsibility changes the way they do their jobs. Because Middleton has done more than simply re-assert that age-old principle that ignorance ranks with dogs and eaten homework as any sort of excuse for failure. In finding against both executive and non-executive directors of the twin towers of financial calamity, Centro Properties and Centro Retail, Middleton has concluded that being honest in error is no protection against failure in diligence. In the end, Centro's directors are to be held accountable for what they did not know but should have. Middleton makes it clear this was not a board of financial novices. The chairman back in 2007 was the heavily-boarded Brian Healey and his boardroom ranks included former National Mutual managing director Sam Kavourakis (who was head of the Centro Properties audit committee), former Coles Myer heavyweight Peter Wilkinson, former BHP and Orica numbers man James Hall and former lawyer Paul Cooper. Their latest Centro humiliation should be the rest of corporate Australia's current homework. The Australian Securities & Investments Commission pursued negligence charges against the executive and non-executive directors of Centro because the 2007 annual reports carried incorrect disclosure on short-term and long-term liabilities. ASIC argued, and the court accepted, that Centro Properties had failed to disclose $1.5 billion of short-term liabilities, calling them non-current instead, and had failed to disclose guarantees over $US1.75bn of short-term liabilities of an associated company. Centro Retail also failed to disclose $500 million of short-term liabilities, again misallocating them as non-current debt. And their mistake, Middleton found, was no mere technical oversight. Financial reports are the cornerstone of a proper assessment of the risks faced by any company. "The significant matters not disclosed were well known to the directors, or if not well known to them, were matters that should have been well known to them," Middleton said in his judgment. The directors are intelligent, experienced and conscientious people. There has been no suggestion that each director did not honestly carry out his responsibilities as a director. However, I have found, in the specific circumstances the subject of this proceeding, that the directors failed to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires of them. Plainly, that is not how the non-executive directors of Centro saw things. They argued several layers of formal review had failed to expose the problems identified by ASIC, that the regulator's standard sought to impose a level of unachievable perfection and, most fundamentally, that they relied on the advice of executive management and the companies' auditors, PricewaterhouseCoopers, in signing off on the 2007 numbers and disclosures. The Centro Eight also argued that their misunderstanding was, in part, a product of confusion over accounting standards in the wake of the shift from AGAAP to AIFRS. To understand that argument you need to recall the boomtime lunacy that was the Centro business model. The core idea was that Centro would make big ticket deals using loads of easily available, relatively cheap bridging finance and that debt would be quickly rolled into longer-term debt instruments. Such was the way before the global financial crisis. The business model was undone brutally by the GFC. When US debt markets shut and the debt rolling stopped, Centro was doomed. But the unpicking of the Centro model is not what this is all about. No, the problem here was more technical and actually pre-dated the collapse to come (although ASIC charges did not). The Centro directors argued they were exposed by the complications triggered by the shift from one accounting standard to another. Under the old rules, bridging finance could be rated non-current, as long as the board had reasonable confidence that it would be rolled on demand. Under AIFRS though, that stance no longer held. Short-term debt was short-term debt. For a diversity of vibrantly expressed reasons, Middleton utterly rejected the Centro Eight's defence. ASIC argued that, if ignorance of the rules was an explanation for failure of any or all of the directors to notice the deficiencies in the accounts and reports, then that ignorance itself bespoke a breach of the duty of care and diligence. And the Yes Prime Minister circularity of the regulator's argument found supporter with Middleton. "It is apparent that the legislative scheme imposes overall responsibility for the financial report and the directors' report upon the directors," Middleton said. It is not envisaged by the Act that directors can simply put the discharge of those functions in the hands of apparently competent and reliable persons, for directors are a part of the process themselves by undertaking the task of approving and adopting the financial statements and reports. Middleton rejected any idea that ASIC was seeking to enforce a new high on standards of directors' accounting literacy. As I have indicated, it is not being alleged that directors need to check the accuracy of figures or accounting treatment. It is being alleged that a director is to have sufficient knowledge of conventional accounting practice concerning the basic accounting concepts in accounts, and to apply that knowledge based upon the information each director has or should have if he or she adequately carried out their responsibilities. Later in his judgment, Middleton added: "I accept that the directors were assured by PwC, by their audit plans, that PwC would audit the accounts to ensure their compliance with accounting standards. Management also assured the non-executive directors that the accounts complied with accounting standards. Further, there is no evidence in this proceeding that PwC did raise any concerns regards the accounts or the capability or diligence of management in the private sessions which management did not attend. Middleton considered carefully whether it was then reasonable, given the complexity and quantum of the numbers involved, to expect non-executive directors to detect the error. They argued that the court should "not embrace the standard of perfection" implied by the ASIC complaint. But Middleton found, first, that "having to deal with voluminous material cannot excuse failing to take sufficient care and responsibility" and, then, that the board had been provided with raw material enough that meant they "would have or should have, accumulated sufficient knowledge." Middleton also found: "A board can control the information it receives. If there was an information overload, it could have been prevented. If there was a huge amount of complexity and volume of information, then more time may need to be taken to read and understand it. The complexity and volume of information cannot be an excuse for failing to properly read and understand financial statements. Recently, a senior director told me he was unlikely to accept invitations to join any more boards. The benefits no longer justified workloads increasingly dominated by compliance or the risks assumed by directors and the boardroom work was no longer as interesting as in Britain or the US. This is a view shared by many and Middleton's decision, and the logic that supports it, will only increase the anxieties over the vulnerability of non-executive directors.