But does overstating the problem hamper efforts to find a solution?
By Elizabeth Fry
Integrated reporting is a hot-button topic for both companies and investors.
The new integrated reporting framework urges companies to turn a spotlight on how their strategy and business model creates value over time.
Under this regime, companies will be encouraged to tell a clear, concise story to investors about future prospects, taking into account all the resources and relationships used by the business, not just the financials. This way, investors and other stakeholders will be able to determine if the business model is resilient over the medium and long terms.
The idea of adopting a holistic approach to reporting – one that recognises more than one form of capital – greatly appeals to investors who are crying out for directors to clarify the long-term picture for value creation.
But directors don’t like talking about the future. Why? They worry about liability.
Directors fear being sued for misleading the market if they outline future plans that don’t eventuate.
Directors have reason to be cautious, says John Purcell, CPA Australia’s ESG policy adviser. “While there is an element of self-interest here, there is also a genuine concern about exposing companies to litigation risk that destroys shareholder value.”
While disclosing forward-looking commentary does expose company Boards to risk of liability, Purcell thinks there is a danger of overstating this risk, which clouds the situation and hampers efforts to find a solution.
“The volume of case law to date doesn’t support the level of hand-wringing,” he says.
Complex web of rules
Such instinctive concerns about directors’ liabilities are understandable, as the Australian experience shows.
“The dilemma for Australia is the sheer number of rules around disclosure,” explains Purcell. “[The country] has a complicated statutory-based continuous disclosure regime so yes, Australia has a particular problem. Worse, these rules interplay with other more general rules that are open to wide interpretation.”
The way continuous disclosure rules interact with breach of duty rules make Australia’s disclosure regime very strict.
The country’s corporate watchdog, the Australian Securities and Investment Commission (ASIC), has aggressively pursued directors for both breaching disclosure rules and breaching directors’ general duty of care and diligence.
Complicating matters is that Australia’s safe harbor provisions – which limit liability and rely on good intentions – do not provide a defence. Crucially, they are narrowly focused and don’t shield directors from liability for forward-looking commentary, which they are required to provide with integrated reporting.
A number of lawsuits have been filed in Australia by aggrieved investors claiming they have suffered at the hands of directors who have allegedly made statements about future prospects that failed to materialise. Still other class actions have likely been settled out of court.
"Directors don’t like talking about the future. Why? They worry about liability."
“Directors worry they’re being hounded by litigation funders who perhaps believe they have a good opportunity to extract wealth from corporations based on investor claims,” says Purcell.
He warns against judging the health of Australia’s reporting regime based on a few high-profile corporate failures, like Timbercorp and Great Southern, which got into strife after the global financial crisis.
Even where charges were brought against directors for significant disclosure failures – as with Centro or James Hardie – the circumstances were very specific or highly unusual.
Purcell points out that James Hardie directors were charged not just for failure to disclose but also for breaching duty of care and diligence rules.
“That underlines the view that ASIC uses care and diligence as a very broad brush – a wide scope mechanism – to attack directors.”
Disclosure rules need tweaking
Most companies find the current disclosure regime amenable. The guidelines are clear: If circumstances change, they must inform the market. If they don’t, then that would be misleading.
“The trouble is where investors claim they have based their decisions on information that is either wrong or outdated,” says Purcell. “If companies make a mistake, and then correct it, the question is how promptly they did it.”
However, with some adjustment to the continuous disclosure regime and a possible widening of safe harbour provisions, directors should be able to confidently comment on the future. They can talk to the market without fear if opportunities do not come to fruition or if further information comes to light that proves management’s assumptions were flat-out wrong.
The Australian Institute of Company Directors suggests the ”continuous disclosure” rule be slightly altered – that the word “immediate” be replaced with “as soon as practicable.” The AIDC also proposes the “business judgment” rule should be a broadband defence available to directors who conduct themselves honestly to permit forward-looking commentary.
The nub of the issue which is, or should be, exercising policy-makers is finding the right balance.
Says Purcell: “There is a way to explain strategy and produce a forward view of intentions and objectives without effectively providing specific guidance on future performance that a shareholder might rely on.”
A second reason for company disclosure taking centre stage is ASIC’s new Operating and Financial Review guidance, released in March. The securities regulator wants companies to discuss future opportunities and risks in a way that isn’t so different to integrated reporting.
“ASIC will need to look at a full reporting cycle before commenting on what companies are saying about future financial years. The regulator will be concerned if companies make bland statements that don’t tell investors where directors see the corporation going – boilerplate statements that are so heavily qualified as to erode any real insight,” says Purcell.
Disclosure not the only risk
According to Jeanne Ng, China Light & Power’s Environmental Affairs Director, who is a member of the International Integrated Reporting Committee’s working group, liability is an issue in some jurisdictions, especially the US.
“Yet there are companies that don’t seem to be concerned about providing some forward-looking commentary information as long as there are caveats.”
To Ng, the benefits of integrated reporting outweigh the problems.
“Directors have a duty to be aware of material ESG issues that affect the business. Importantly, integrated reporting would help raise such matters that are not raised regularly at Board meetings, especially when potential ESG risks are higher because of the proliferation of social media and real-time communications.”