Bad directors risk jail for misconduct

Company directors could face criminal charges for serious misconduct and neglect of their duties as a result of a broad review of securities regulation and enforcement.

The Ministry of Economic Development says in a discussion document that it has not come to any conclusions yet, but it considers the case for new criminal offences appears stronger than the alternative of civil remedies.

Securities Commission chief executive officer Jane Diplock has been pushing for new enforcement powers to restore confidence in capital markets after investors lost billions of dollars through an ongoing series of finance company failures.

Diplock was heavily criticised for not taking stronger action against those companies and their operators, but she argues the Securities Commission and other bodies were hamstrung by weak and fragmented enforcement powers.

Diplock believes change is needed so regulators can investigate the management of companies more broadly, to hold directors accountable to operate in the best interest of shareholders or depositors.

Under the existing regime, the Securities Commission can hold directors accountable only for disclosures made in their prospectuses.

Diplock said the current private enforcement regime doesn't work and public enforcement, by a new unified super regulator, is required.

Australia, where criminal charges can be laid against directors for both recklessness and dishonesty in their general duties, appears to be providing the model for New Zealand's new structures. Diplock said adopting a similar regime would have the added benefit of harmonising enforcement as New Zealand and Australia move towards a single economic market.

"It's strange that directors can behave differently on different sides of the Tasman and receive different enforcement action," she said.

Diplock pointed to action taken in Australia after the $A5.5 billion collapse of HIH Insurance as an example. In 2005, former director Rodney Adler was sentenced to four-and-a-half years' jail for, among other charges, failing to discharge his directors' duties in good faith and in the best interests of the company.

"That would be impossible here," she said. The fear, however, is that fewer people will accept director's duties and that boards will become unduly risk averse.

William Whittaker, research and policy manager at the Institute of Directors, said the institute supports regulation which is clear and unequivocal about deterring dishonest or reckless actions by directors. However, the regulatory regime should not be so punitive that it stifles expanding the pool of director talent, and directors need to have confidence they can operate effectively.

"Directors for such an environment need to be competent, ethical and fully aware of the moral and legal implications of their fiduciary responsibility, especially as an agent of the owners. In the experience of the Institute of Directors, there is scope for improvement in the general director community," Whittaker said.

"The institute would be concerned if the shift represented a move toward allowing a regulator to second guess a rational action or business decision with the benefit of hindsight with a view to holding directors personally liable for company and shareholder losses," he said. "The prospect of financial loss is a necessary consequence of a competitive economy."

Corporate governance is not on trial, Whittaker said, merely how it is practised and policed.

"The emphasis at all times must be on fiduciary responsibility, that is acting in the interests of the company at all times," he said. "Market failures have centred on sloppy practice, poor judgement and, often but not always, fraudulent activity where self-interest has been placed above the interests of shareholders/owners and inside knowledge has led to illegal practice."

Whittaker said breaches of duties under the current system are usually policed by the liquidator as the agent of the company when it is insolvent.

"Some view this as the courtroom at the bottom of the cliff, seeking accountability after the damage has been done and not offering suitable redress for investors."

The proposed changes would enable the new Financial Markets Authority (FMA) to take action against directors while the company is still a going concern. Among other regulatory changes flagged in the discussion document, and again based on Australian models, the new FMA may also gain the power to initiate civil action on behalf of investors.

COMMON MALPRACTICES

The Ministry of Economic Development's securities review discussion paper says misconduct by directors can include:

- Selling assets they own to the company for more than economic value

- Obtaining assets from the company at less than their economic value

- Buying or selling company shares using information got as directors

- Not putting sufficient effort, or applying sufficient skill, when making decisions on behalf of the company

- Taking excessive risks with remaining assets of an insolvent company

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