To what extent can a senior officer acting in a supervisory role rely on an Executive Director performing an operational function?
In the recent decision of Vines v The Australian Securities and Investments Commission [2007] NSWCA 75 the NSW Court of Appeal held that that the reasonableness by an Executive Officer of reliance on information provided to him by an Executive Director will turn on the role and responsibilities of the officer, and the significance of, or the risk associated with, the issue that is the subject of that reliance.
It was held that the CFO Mr Vines had not exercised the degree of care and diligence required under section 232(4) of the Corporations Law (now section 180(1) of the Corporations Act 2001) when he relied on a profit forecast provided to him by an Executive Director of a subsidiary company in circumstances where Vines played a pivotal role in the response to a takeover bid and the key to that response was the accuracy of the profit forecast.
The Vines case impacts on the ability of senior officers to rely on executive directors to exercise the operational functions for which they are responsible, demonstrating that in certain circumstances supervising officers will be required to review for themselves the information they are given to verify its accuracy.
The Corporations Act now contains section 189 specifically dealing with reliance in relation to directors. The Vines case continues to be of relevance to officers, to whom the legislative provisions do not extend, and may be instructive in determining how section 189 will be interpreted.
Background
GIO Australia Holdings Ltd was a listed public company, and parent of the GIO group of companies. GIO Insurance Ltd was a subsidiary of GIO Australia. GIO Re was the reinsurance division of GIO Insurance.
Vines was the Chief Financial Officer of GIO Australia, but not a director. The Executive Director of GIO Insurance was Mr Fox. Fox played an operational role, the responsibilities of which included providing profit forecasts, determining profits and determining reserves. Vines' role as CFO was supervisory, not operational.
In 1998, a subsidiary of AMP Ltd made a takeover bid for GIO Australia. The bid became hostile. As required, the GIO board published a Part B Statement (a "target's statement" under the Corporations Act), which included a profit forecast that relied on GIO Re contributing $80 million to that profit.
In 1999, following closure of AMP’s offer to GIO shareholders, GIO Re announced a loss of $19.6 million for the six months ending 31 December 1998.
Approximately one month after AMP announced its takeover bid, and while the Board was still preparing the Part B Statement, Hurricane Georges hit the US, exposing GIO Re to substantial claims as a result of the damage. The final claims figure could only be estimated for the purposes of the profit forecast in the Part B Statement. GIO set up a Due Diligence Committee ('the DDC') to prepare the Part B Statement. Vines was a central member of that committee.
ASIC alleged that Vines had failed to exercise due care and diligence in relation to the Part B Statement by failing to inform GIO Australia or GIO Insurance, their directors and management, the DDC or the financial advisors of the group of the potential effect of the hurricane on the $80 million profit forecast for GIO Re, and the improbability that GIO Insurance would achieve that figure.
Vines argued that he did exercise due care and diligence. He claimed that he had a supervisory role only, and that he relied on Fox as the Executive Director of GIO Insurance to perform an operational role, which included procuring proper estimates of GIO Re's exposure to Hurricane Georges claims for the purpose of the profit forecast.
The profit forecast for GIO Re of $80 million was based on the following key assumptions:
- Claims in respect of Hurricane Georges would not exceed $25 million
- Even if they did, GIO Re would obtain a "retrocession policy" pursuant to a contract with another reinsurer, which would transfer any risk of exposure exceeding $25 million to that reinsurer for accounting purposes; and
- If inadequate provision existed for Hurricane Georges claims, an adjustment to GIO Re's excessive provision for exposure to professional negligence and other risks (an "unders and overs" analysis) could be made.
Vines was relying on Fox to keep him informed of the extent of the exposure to Hurricane Georges claims. Prior to 11 November 1998 he believed Hurricane Georges liability would not exceed $25 million. On 11 November 1998, Fox knew that a contract-by-contract review had produced a maximum potential loss of $105 million, but Vines believed Fox when he gave management's best estimate of liability at $60-65 million. He also believed that GIO Re was on the point of finalising a retrocession policy that would protect the projected profit. When Vines discovered on 7 December 1998 that the external auditors would not accept the accounting treatment of the retrocession policy necessary to protect the profit figure, he was unaware that total gross claims had risen to $91.9 million.
The rejection of the retrocession policy, only nine days before the Part B Statement was due to be published, made the "unders and overs" analysis the only means of protecting the integrity of the $80 million profit forecast. An "unders and overs" analysis was conducted which was only just adequate to maintain that profit figure. The calculation being "tight", the accuracy of the assessment of the Hurricane Georges liability was now far more important than before. In these circumstances, was it still appropriate for Vines to rely on the exposure estimates provided by Fox, or should he have confirmed their accuracy himself?
The majority: reliance not justified
The majority of the Court of Appeal (Chief Justice Spigelman with whom Justice Ipp agreed) agreed with Justice Austin at first instance that Vines' reliance on Fox was unjustified.
In coming to this conclusion, both judges focused on two factors central to the consideration of whether reliance will be justified:
- The role and responsibility of the person seeking to justify reliance (in this case, Vines); and
- The significance of the factual circumstances in which reliance takes place (here, the takeover bid).
The roles and responsibilities of Vines and Fox were intended to be quite distinct. Fox was responsible for the operational side of the business, and management, to a point, could rely on Fox to undertake those duties.
However, two significant events occurred in the second half of 1998 which impacted on the characterisation of Vines' role for the purposes of reliance.
First, a new governance structure brought Vines into closer contact with financial matters at a divisional level, albeit still in a supervisory role. On several occasions Vines directly intervened at the divisional level where he felt, from a group level perspective, that it was warranted.
Second, Vines assumed a pivotal role in the response to the AMP takeover bid. Among other things, this involved attending meetings of the takeover response committee and the Part B working group, and the performance of a central executive role in the DDC. Vines played a prominent part in the Part B profit forecast for GIO Insurance.
The prominence of Vines' role and responsibilities in the takeover bid had the effect of blurring the supervisory/operational boundary between him and Fox, and ultimately led the majority to conclude that reliance on Fox was not justified. That is, Vines could not simply accept Fox's estimates for the purposes of the profit forecast. This conclusion was further supported by the frequency with which Vines was found to have intervened directly in matters within the operational responsibility of Fox at GIO Re in the past. The fact that Vines could and did intervene where he felt it was necessary strengthened the case against his reliance in the especially significant context of the Part B profit forecast.
The majority also placed considerable emphasis on the critical nature of the factual circumstances in which reliance took place. Indeed, for Justice Austin at first instance, this factor appears to have been the one to have tipped the balance. Thus his Honour found reliance on Fox was justified up until 8 December 1998 (while the accuracy of the estimates was less significant, given that the retrocession policy was still thought to be an option), but could no longer be justified once the retrocession policy was rejected and it became apparent that the "unders and overs" analysis was the sole remaining means of maintaining the integrity of the original profit forecast, and that the accuracy of the estimates was paramount.
The dissent
Justice Santow dissented, holding that Vines was entitled to continue to rely on Fox to keep him informed on the basis of the supervisory/operational divide in their respective roles.
Justice Santow found that reliance was reasonable on the basis of Vines' limited knowledge of the progress of the Hurricane Georges claims and the distinction between his (at least ordinarily) supervisory role and Fox's operational responsibilities, which led Vines to accept the information which Fox provided in the course of his operational duties.
Further, as his Honour found that Vines had no reason to think that Fox had failed in his responsibility to provide proper estimates of the exposure, he concluded that there was no requirement for Vines to do Fox's job as well as his own.
Warning signals
There was some disagreement as to whether a particular "event" must have taken place to put Vines on notice that Fox's estimate could not be relied upon, and that personal investigation was necessary.
Both Justices Ipp and Santow seem to have considered that some kind of event was necessary. Indeed, the latter's dissent appears to have been largely based on the fact that in his Honour's opinion, Vines had no reason to believe that he was not receiving up-to-date information on the exposure figures. Justice Ipp referred to a number of warning signals (including the external auditors' cautions that attention should be given to the extent of potential liability for Hurricane Georges), which would have led a reasonable person in Vines' position to take steps to verify Fox's advice regarding exposure estimates.
On the other hand, Chief Justice Spigelman stated that such a warning event was not required, although his Honour observes that such events had taken place in any case.
The Corporations Act
The ramifications of Vines must now be understood in the context of specific requirements for reliance by directors on others that were not in place during the time period relevant to the Vines case. The Corporations Act 2001 (Cth) now contains section 189 which provides, relevantly, that, unless it is proved that such reliance was unreasonable, a director may rely on information given or prepared by an employee, another director or an officer provided that the information is within the provider's authority or competence, and the reliance is made in good faith and after making an independent assessment of it (having regard to the structure and complexity of the corporation).
Importantly, the section is expressed to apply to directors rather than officers. Consequently, it does not directly affect individuals who, like Vines, are officers but not directors. Further, it may also suggest a lacuna in the Corporations Act which extends directors' duties to officers but not directors' protections, such as presumptions regarding the reasonableness of reliance.
Consequently the Vines case will continue to be of relevance to officers, to whom the legislative provisions do not extend, and may be instructive in determining how section 189 should be interpreted.
Conclusion
The message is that where the responsibility of the officer is such that the role they perform may be seen as something more than merely supervisory, or where the information they seek to rely on is of particular significance, officers should be vigilant and should consider scrutinising the information to verify its accuracy and reliability for themselves.