ASIC yesterday achieved a stunning victory with the Federal Court ruling that eight Centro directors breached their directors’ duties in failing to accurately disclose the company’s liabilities to shareholders in the 2007 financial report. The decision, while setting a precedent for directors’ responsibilities, like most corporate prosecutions, had little to do with causes of Centro’s actual downfall, and more to do with defining the roles of board members.

Centro Properties Group was a highly leveraged and complex creature, created largely by former chief executive Andrew Scott. Once valued at almost $10 billion by the market (with $26.6 million in funds under management), the share price collapsed in December 2007 when the company revealed that it was struggling to refinance $1.3 billion. Centro was effectively taken over by lenders and remains listed on the ASX with a value of $37 million.

While the Centro board and its auditor PwC (which is the subject of a separate class action from Slater + Gordon and Maurice Blackburn) were derelict in failing to inform shareholders of the current liability levels, that omission was not the reason for Centro’s collapse. Rather, it was the extraordinary amount of leverage used and the ill-timed acquisition of US-based New Plan Excel Realty for $4.7 billion in March 2007 that caused the downfall. (Courtesy of the “business judgment rule”, no action could be taken against Centro for the catastrophic acquisition, instead, ASIC took civil action for poor disclosure).

Justice John Middleton yesterday ruled that Centro’s eight directors, including Scott and chairman Brian Healey, breached their directors’ duties by failing to disclose that the company had almost $3 billion in short term debt in the 2007 annual report. Justice Middleton found that:

Each director knew of the current interest bearing liabilities and of the guarantees. Each director was aware of or should have been aware of the relevant accounting principles which would have alerted each director to the apparent error in the proposed financial statements. Each director could then and should have made the relevant inquiries, if they had taken all the reasonable steps required of them. The directors did not focus upon or properly consider the issues the subject of ASIC’s allegations.

The court then concluded that “the failure to notice certain omissions may well be explicable — but here the directors, in some cases on their own admission, clearly looked solely to management and external advisers. If they had acted … as the final filter, taking care to read and understand the financial accounts, the errors may have been discovered earlier than they were”.

On one hand, it is easy to feel a degree of sympathy for the directors. They are like the proverbial drunk driver who hits a pedestrian en route home. Other people may be driving drunk (so are just as culpable) but get away with their actions simply because they were lucky enough to not come across an innocent victim. By the same token, the Centro directors are certainly not the only directors who failed to adequately review their company’s financial results. They, however, happened to have the misfortune of being directors of a company that collapsed soon after.

The Centro directors were, nevertheless, well paid and highly financially literate. Scott was the architect of Centro and a former Coles Myer executive with extensive experience in property and debt structuring. Scott received remuneration of more than $3.5 million per year. Audit committee chair Sam Kavourakis had been the managing director of National Mutual for eight years and was the director of several other public companies. Kavourakis was paid $167,000 annually by Centro. Another director, Jim Hall, was a fellow of the CPA (a leading accounting body), and had been vice-president of group accounting and controller at BHP Billiton and a director and CFO of Orica. Hall remains on the Centro Properties and Centro Retail boards and also is a director of ConnectEast, Alesco and Paperlinx. Hall was paid $684,000 for his various board roles last year. Current Centro chairman Paul Cooper was a former solicitor and since 1995 had been a director of AXA Asia Pacific Holdings Ltd and a member of the Audit and Compliance Committee of that board.

While these directors were relying on advice from their well-paid auditor, they clearly had a responsibility to use their knowledge and background to undertake further investigations as to the true financial position of the company.

The decision of the Federal Court will be causing angst at PwC (and the firm’s insurers). PwC were also specifically referred to in the judgment, with a $200 million shareholder class action against the firm scheduled to commence in March 2012.